Hey @Paul Azad and others. I just saw this, and though I am 5 months late to the party, I want to answer some of these questions for the record.
As a disclaimer, I want to mention that every investment has risk and there is no guarantee of any return on this investment or any other investment. And note that this investment is closed to new investors, so it is unavailable now (it filled up in 3 business days). Our investments are available for accredited investors only.
The targeted returns are net of all fees. So, the ongoing net cash yield of 6.5% to 8% is net to investors. And the total projected return of 14% to 15% is net to investors (rather than 11.2% - you would be correct if those fees had to come out). @Evan Polaski was correct about this being net.
Note that we also held back $3.9 million of the $5.5 million raised in this sidecar, so there was only about $1.6 million “at risk” originally. And this means that we are earning interest at ~ 4.5% to 5% or so on the balance we are holding back. That all goes into the return (as a “bonus”).
There is about 20% in common equity in first-loss position behind us. Meaning the asset could lose 20% or so of its value before impacting our position.
The asset was purchased for $20.2 million with assumed fixed Fannie Mae debt at 4.91% (term through 3/2034).
There was a good bit of understandable discussion about the terms…how we mitigate risk for ourselves and investors. Here are a few bullets on this topic:
- 1. Full return of capital & accrued upside to pref equity before common equity gets distributions from capital events, including return of capital
- 2. Wellings preferred equity receives the same depreciation allocation as common equity, and sidecar investors receive a K-1 annually
- 3. Forced sale rights in the event of pending lender foreclosure
- 4. Holdback of capital improvement budget to be released in draws as work is completed per Wellings’ unilateral approval plus annual budget approval rights
- 5. While no technical control rights due to FNMA requirements, the budget approval process gives Wellings “the power of the purse”
@Evan Polaski was correct again in saying that we do not provide rescue capital and we definitely don’t raise pref equity to bail out our own troubled deals. And that we had to get a higher return to offer this net return to investors. And that we have to underwrite an enormous number of deals to make a few pencil. Last year we looked at 515 operators and deals and only invested in 11. And we already knew 7 of those operators!
So why on earth would someone pay us about 17% total for preferred equity. There are a lot of potential reasons.
- 1. The sponsor can take us out after a few years. This will give the sponsor and/or the LP investors significant additional ownership. If they are long-term holders, this can be significantly accretive to their wealth.
- 2. Preferred equity allows the sponsor to assume a low-interest loan that they can keep in place for about a decade. The math makes sense.
- 3. This experienced sponsor “knows” they can invest our capital to raise rents and revenue at a level higher than the cost of capital. This asset has clear intrinsic value/value-add potential that is hard to acquire in multifamily these days.
Last, @Ned Carey, I agree with you. I recommend everyone get Brian’s book. Brian
is a friend, and he lives out what he wrote!
And if you're planning to invest in CRE passively, check out www.passivepockets.com – it just went live today!
