Equity-like capital with priority returns, sitting above common equity.
Preferred equity is a capital investment that sits between mezzanine debt and common equity in the capital stack. It's structured as equity (typically a preferred LLC interest) but has priority distributions and a defined return schedule — bridging the gap between true debt and true equity in both risk and return.
Preferred equity behaves like debt in some ways (priority returns, defined coupon) and like equity in others (no foreclosure remedy, no security interest in the property). Pref equity holders sit above common equity in the distribution waterfall — they get paid first from cash flow and sale proceeds — but below all true debt (senior and mezz). The result is a hybrid instrument with a risk/return profile between mezz and common equity.
Pricing typically lands in the 8–14% preferred coupon range, often with additional "kickers" — preferred return accrual if not paid currently, partial profit-share above the coupon at sale, or step-up provisions at certain time milestones. Hard pref (no profit share) prices like debt at the lower end of the range; soft pref (with upside share) prices lower coupon plus equity-like back-end.
Pref vs. mezz trade-offs: Pref is typically cheaper in coupon (8–14% vs 11–16% mezz) but has weaker remedies in default. A mezz lender can foreclose on the LLC interest if not paid; pref equity holders typically can only withhold distributions to common equity and exercise rights under the operating agreement (forced sale, change of management, etc.). Pref is also slower to default — the equity nature of the investment gives more flexibility.
Sponsors use pref equity strategically. When senior debt + mezz + sponsor equity still doesn't fund the deal, or when the sponsor wants to avoid mezz's stronger default remedies, pref equity fills the gap. Pref is also more flexible on payment timing — if cash flow is light, pref can accrue rather than triggering immediate default. This makes pref popular on transitional and value-add deals where cash flow timing is uncertain.
| Capital stack: | |
| Senior debt: $18M | (SOFR + 350) |
| Mezz debt: $3M | (12% fixed) |
| Preferred equity: $4M | (10% pref + 25% upside above 10%) |
| Common equity (sponsor + LP): $5M | |
| Waterfall at exit: | |
| 1. Senior debt fully repaid | |
| 2. Mezz debt fully repaid | |
| 3. Pref equity receives 10% IRR | |
| 4. Common equity receives capital back | |
| 5. Above hurdle: 75% common, 25% to pref (profit share kicker) |
A capital investment that sits between mezzanine debt and common equity. Structured as equity with priority distributions and a defined return schedule — hybrid between debt and equity.
Mezz is technically debt (with foreclosure remedies on LLC pledge); pref is equity (with weaker remedies but more payment flexibility). Mezz is typically more expensive but offers stronger lender protection.
8–14% coupon, sometimes with a profit-share kicker at exit (20–35% of upside above the hurdle rate).
Yes — sophisticated capital stacks often have senior + mezz + pref + common equity, each at different risk/return profiles. Intercreditor agreements govern the relationships.
When the deal needs more capital than senior + mezz + sponsor equity can fund, or when the sponsor wants to avoid mezz's stronger default remedies. Common in development, value-add, and large-scale acquisitions.
Matrix structures senior debt in capital stacks that include mezz and preferred equity — coordinated execution across the entire stack.
