What is preferred return in real estate?

Preferred return refers to the order in which profits from a real estate project are distributed to investors. In other words, preferred return indicates a contractual entitlement to distributions of profit. The priority of this distribution is maintained until a predetermined threshold rate of return has been met. Once met, profit distributions are made to any other subordinate stakeholders in the investment.

Is preferred return the same as preferred equity?

Preferred Return and Preferred Equity are different concepts that are often closely related. Preferred equity refers to a specific position in the capital stack, senior to common equity and subordinate to debt. Preferred Equity gets paid out before Common Equity and is priced at a certain percentage return, called a preferred return. That return can be paid current out of cash flow, accrue, and be paid upon a sale, or a combo of both. Upon repayment of preferred equity, the remaining cash flow goes to common equity partners (through a distribution waterfall). Often, the first two tiers of the distribution waterfall are 1) the return of principal and 2) a different preferred return up to a threshold rate of return (8%, for example). These two tiers can be interchangeable, depending on the investment’s Operating Agreement. Generally, both the GP, or “sponsor,” and the LP (EquityMultiple and its investors) will receive a return of capital upon sale of the property, all other cash flow will go toward the preferred return, and then a portion of the remaining profits until both the GP and LP get to the 8% return threshold. Preferred equity investments always entail a preferred return. A preferred return hurdle may also be in play for common equity investments.

Real Estate Concepts - October 20, 2023

Preferred Return in Real Estate: What Investors Need to Know

October 20, 2023

By Soren Godbersen

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Soren Godbersen

Soren is Chief Growth Officer at EquityMultiple. Since the launch of the EquityMultiple platform in 2015, he has overseen customer communications and educational content development. Soren is responsible for the ongoing development of the EquityMultiple brand, ensuring a great investor experience, and pursuing sustainable growth for the company. Prior to EquityMultiple, Mr. Godbersen worked on major product development and marketing initiatives for SaaS companies. He holds a degree in Economics from Whitman College.

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