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HomePassive IncomeWhat is Preferred Equity & How Do I Invest in It?

What is Preferred Equity & How Do I Invest in It?

There’s a huge opportunity in the current real estate market—and you need to put it on your radar. Have you ever heard the term, “preferred equity?” 

It’s part of the real estate capital stack—or how all of the money of a deal is stacked up—and can be a smart way to bridge the gap in commercial real estate investing. If this isn’t something you’ve dabbled in when investing in passive real estate, now’s the time. 

But wait…isn’t equity all the same? Before I got into passive income through real estate, I certainly used to think so. I soon realized that common equity is different from preferred equity, and that investing in the latter could give me a higher ROI and sooner—as well as other benefits. 

Sure, “preferred equity” might not be the most exciting topic to talk about. But I’m writing with high energy today because I’m looking at the big picture. With an investment opportunity like this, I know I can create passive income streams outside of medicine that will let me live life on my own terms, creating that financial freedom of my dreams. 

But first, let’s clarify what preferred equity actually is because it can be confusing. It represents a type of ownership in a company or deal that typically grants shareholders priority over common equity holders in receiving dividends and proceeds from asset sales. 

For example, let’s say a real estate deal has a senior loan, preferred equity investors, and common equity investors. In that situation, the preferred investors are smack dab between the senior loan and common equity folks, in terms of who gets paid. If the property sells, the senior loan is paid off first, then the preferred equity partners are paid next, all but guaranteeing that the sale will cover their returns. 

Unlike common equity, preferred equity often offers fixed or adjustable-rate dividends, resembling characteristics of both equity and debt securities. Today, we’ll cover the benefits of choosing preferred equity for commercial real estate investment and how to get started. 

There’s one thing not to forget in all of this: preferred equity is still equity. And it can actually be a quicker way to get a higher return, especially if you know how to use it for commercial real estate. But be careful and use your due diligence. 

Steady Income

Investors in preferred equity generally seek a balance between steady income and capital preservation. It’s like a Goldilocks situation: not too cold, not too warm. Preferred shareholders have a lower risk profile compared to common stakeholders but bear more risk than debt holders. Because of this, preferred equity tends to have projected returns—medium risk for medium reward. With fixed rates of return, it provides investors with predictable income streams. 

Why are projected returns a good thing? Investing in preferred equity typically involves shorter timeframes for deal completion, allowing for quicker investment turnaround and maximized capital gains. You can earn money and put that money back into a new investment. Additionally, regular distributions from preferred equity investments provide investors with steady income streams, enhancing and diversifying portfolio stability. 

It also gives you options on setting a timeframe for your returns. For example, what’s called “current” preferred equity is set up to pay you every month or each quarter. This is nice for folks looking to create steady cash flow. On the other hand, there’s also “accrued” preferred equity, which means payments are building up on paper but won’t be sent out until later. These deferred deals might be useful for tax purposes of higher rates of return (with greater risk).

Choosing what mix of preferred equity investments you want is a choice you have to make depending on your portfolio, risk tolerance, and investment preferences. 

Cash Flow

This class of equity is abundant in the market today because of high interest rates. Because rates are high, sponsors and operators are getting creative with financing to get capital. That means this is the perfect opportunity to get in on a type of real estate—commercial real estate—that usually has a high entry point. 

For me personally, when an opportunity like this arises, I like to take a portion of my portfolio to put towards preferred equity because it’s heavy on cash flow. Sure, the returns are capped most of the time, but it creates a little bit more predictability with incoming cash.  

  1. Educate Yourself: Begin by learning about preferred equity real estate investing, including its benefits, risks, and how it fits into your overall investment strategy. Join communities of like-minded people, like ours here at Passive Income MD, to begin your education. 
  1. Research Opportunities: Explore various real estate investment opportunities offering preferred equity structures, considering factors like location, property type, and investment terms.
  2. Evaluate Risk and Return: Assess the risk-return profile of preferred equity investments, considering factors such as fixed returns, potential for capital appreciation, and the financial strength of the underlying real estate projects.
  3. Network and Build Relationships: Connect with real estate developers, sponsors, and investment platforms specializing in preferred equity deals to access opportunities, learn how to ask the right questions, and gain insights into market trends. Join groups like the Passive Real Estate Academy, where like-minded people are looking at deals together. 
  1. Perform Due Diligence: Conduct thorough due diligence on potential investments, including analyzing financial documents, assessing property fundamentals, and evaluating the track record of the sponsor or developer. Go to your team of professionals–such as your CPA and financial advisor—for help with this. Just because a sponsor promises great returns doesn’t mean it’ll happen. 
  1. Invest and Monitor: Once you’ve selected preferred equity investments that align with your goals and risk tolerance, invest capital and actively monitor the performance of your investments over time.
  1. Diversify Your Portfolio: Consider diversifying your preferred equity real estate investments across different properties, locations, and sponsors to mitigate risk and optimize overall portfolio performance.
  1. Stay Informed: Stay updated on market trends, regulatory changes, and economic indicators that may impact the performance of your preferred equity investments, and adjust your strategy accordingly.

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Why wait any longer? Keep digging and learning to create your ideal life through different streams of income. Take action today to find the preferred equity opportunities in real estate that get you closer to reaching financial freedom and living life on your own terms. 

We here at Passive Income MD want to support you on that journey, so connect with us in one of our many communities, at our events and conferences, or at Passive Real Estate Academy. Wherever we see you next, we look forward to collaborating with you, learning with you, and working together to find life-changing preferred equity deals. Until then, stay inspired and keep challenging yourself to grow as an investor. 

Peter Kim, MD is the founder of Passive Income MD, the creator of Passive Real Estate Academy, and offers weekly education through his Monday podcast, the Passive Income MD Podcast. Join our community at the Passive Income Doc Facebook Group.