A 9 percent preferred return on a crowdfunded deal is a target, not a payment schedule

Worth laying out as a case, because it is a common misread for a first-time crowdfunding investor coming from direct ownership. Say 5k goes into a value-add apartment deal on a platform, 82 units, plan to renovate units as they turn and refinance in year three. The deal page advertises a 9 percent preferred return with quarterly distributions. Read casually, that looks like a fixed quarterly payment showing up like a paycheck, with equity upside as a bonus on top. In practice, distributions can and do get suspended, for example to fund the renovation budget or cover insurance costs running above what was underwritten, sometimes as early as month seven, with nothing paid for a year or more after that. The updates from a sponsor in that position can still be entirely honest, occupancy fine, renovations simply slower than planned, with nobody having done anything wrong. The part that is easy to misunderstand: a preferred return means the investor sits ahead of the sponsor in line for profits up to that percentage each year, but if the property does not generate cash, there is no cash to send. Some deals accrue the unpaid preferred, meaning it piles up as a claim to be paid from a refinance or sale before the sponsor's split, and some do not accrue at all. The documents specify which. Money in that position is not lost, it is parked with an unpaid claim and no fixed date attached. The useful habit going forward: before funding, find the sentence stating whether the preferred return is paid in cash from operations or accrued, and check what the projected first-year cash flow actually covers. If a deal's own numbers barely cover the year-one distribution, that distribution is more hope than plan.

2 replies

tylerbrooks9 AO1APRO 10

Thank you for writing it plainly. This is the exact fear that keeps a lot of first time passive investors going back and forth between deals like this one and a plain pooled index style vehicle, when what they want is the boring income version. One point worth pinning down in the documents, since it decides how much a two year slip really costs. Cumulative means the unpaid preferred return carries forward and has to be paid before the sponsor sees a promote. It does not on its own mean compounding. Some agreements accrue the shortfall as a flat number and some let the accrued balance earn the preferred rate, and the word cumulative gets used for both. The operating agreement will say which one applies here.

tylerbrooks9 AO1APRO 10

angela_burke CP4CPRO 12

Verity, cumulative means the unpaid amount carries forward instead of resetting each year. Whether it also compounds, meaning you accrue on the unpaid accrual, is a separate line in the agreement and the two get written a dozen different ways. Read the waterfall section. Girder, the insurance overrun is worth sitting with. On renovation jobs generally, insurance and materials are the two lines that move the most between when a budget is written and when the work starts, and a plan that only pencils if both hold is a plan with no room in it. You can spot that from the outside by asking what the sponsor's contingency was as a percentage of the renovation budget. Under 5 percent on unit turns deserves an explanation.

angela_burke CP4CPRO 12

A 9 percent preferred return on a crowdfunded deal is a target, not a payment schedule

2 replies