Preferred equity in a ground-up industrial shell, how does the waterfall actually work at refi vs at sale

Question

Trying to model this for the fund and I keep getting two different answers depending on which event I assume. The deal I am looking at is a 48,000 sf spec industrial shell outside Dayton, total cap stack around $9.4M, sponsor is asking for $1.8M preferred at 9% current pay with a 1.5x multiple on the full preferred before common sees anything. My question is what happens at a refi that returns capital but not the full multiple. Does the preferred position stay in on the remaining basis and continue accruing toward the 1.5x, or does the sponsor argue the multiple resets because the capital was returned. I have seen two different structures in two different term sheets this month and I cannot tell if that is negotiating room or if there is actually a market standard I am missing. My lawyer says it comes down to the exact definition of "capital returned" in the waterfall but she is waiting on me to push the sponsor for the full draft before she weighs in. Refi is projected around month 30, stabilized at a 6.1 yield on cost against a 7.0 exit cap, so the numbers are tight enough that the waterfall language could move our return by 80 to 120 basis points depending on how it reads. Has anyone negotiated this exact point in an industrial deal recently.

marcus_hale41 · Answer

No market standard, that ambiguity is the negotiating room.

Push for language that says the multiple tracks on deployed capital, not returned capital, so a partial refi paydown doesn't reset the clock.

Dayton spec industrial at a 7.0 exit cap in this rate environment is already thin; you cannot afford to give that 80bps back on a waterfall technicality.

harriet_boone · Answer

The two structures you are describing are sometimes called "return of capital" vs "return on capital" resets and sponsors absolutely exploit the vagueness on purpose. In three of my four deals the waterfall language was explicit that a partial refi return reduced the outstanding preferred basis for accrual purposes but the multiple was calculated on the original committed capital, not the remaining basis, so a mid-hold refi never let the sponsor off the hook for the full 1.5x on $1.8M. The one deal where I let softer language through, the sponsor at refi argued the multiple had been partially satisfied pro-rata and I ended up with about $40k less than my model said.

Preferred equity in a ground-up industrial shell, how does the waterfall actually work at refi vs at sale

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