A preferred position that runs 0.83x combined coverage on day one, carried by a reserve

Anchor has the mechanic right and it cuts both ways. A funded interest reserve does mean part of your stated return is your own capital coming back to you, so the true yield on capital genuinely at risk in the property is lower than the coupon suggests. It also means the payment cannot be missed for as long as the reserve lasts, which removes the early default trigger that would otherwise give you a remedy while there is still value to protect. That is the trade sextant is actually pricing.

On the numbers as posted, the exit test is the more useful constraint. $1.89M of NOI to be whole at 1.30x against $1.72M in place is a 10% requirement, and the sponsor's plan calls for 37%. That gap is the cushion. Whether it is enough depends on two assumptions doing most of the work. First, the 6.25% exit cap. At 6.75% the same 1.30x needs about $2.04M, which is 19% growth, and the cushion halves. Second, the $8,000 a door on 96 units, because a scope that runs 20% over consumes roughly $420k that has to come from somewhere, and the only somewhere in this structure is the reserve or a capital call.

On the last question, funding current pay from your own principal is common in value-add recapitalizations where in-place income cannot carry a full stack. What makes it defensible is whether the reserve outlives the point at which operations cover the payment, so run the month-by-month and find the crossover month rather than the annual average. If the crossover sits at month 30 and the reserve empties at month 42, ask what happens in the twelve months where there is neither reserve nor coverage in the downside case.

The reserve is both the protection and the thing that hides the problem. That reframes the whole structure worth watching for.

$8,000 a door on 96 units of 1980s stock, is that interiors only or does it include anything mechanical? Because on a 40 year old building the number that shows up uninvited is a chiller or a sewer line, and that isn't in a per door interior budget anywhere I've seen.

The 96 of 140 units matters for a reason nobody's said yet. That's a two and a half year turn program at roughly 3 units a month, and if renewals hold better than projected the operator can't get into the units to do the work. A plan slipping nine months because tenants won't leave sounds like a good problem and isn't. The NOI ramp assumes turnover the sponsor doesn't control.

Agreeing with quarry and adding the other direction. If turnover gets pushed to hit the schedule, vacancy runs hotter than the model for most of two years and the $250k of available cash goes to zero or negative. Then the reserve drains faster than $310k a year and a 42 month runway turns into 28. Worth asking for the reserve draw schedule under a 90% economic occupancy case rather than the 94% likely used in the base model.

Checked your exit math. $22.4M plus 1.30 times $5.6M is $29.68M, gross at 2% costs is $30.29M, at 6.25% that's $1.893M. Ties out. The thing I'd add is that the senior is interest only for three years, so there's no amortization helping you and the $22.4M in that equation stays $22.4M. If the loan had a 30 year amortization schedule you'd have knocked maybe $800k off it over the term and your break-even NOI drops to about $1.84M. IO helps the sponsor's cash flow and costs you cushion at the exit.

Meridian, that's the first time I've understood why interest only isn't automatically good for everyone in the stack. Thanks.

I'd stop optimizing the coupon and go after the structure, because at 82% last dollar the difference between 14% and 15% is worth about $56k a year and the things that will actually decide this outcome are worth multiples of that.

Four items I'd push before price.

The reserve needs to be sized against a downside operating case, not the shortfall in the base case. Run economic occupancy 400bp light with the turn program 9 months late, as trellis described, and find the month the reserve hits zero. If that's month 26 and your coverage crossover is month 30, the reserve is undersized by whatever fills that gap and no coupon fixes it. I'd rather have $1.6M of reserve at 14% than $1.1M at 15%.

Second, get a hard replenishment obligation. If the reserve drops below some floor, sponsor funds it within 15 days or it's a default, with the cure period short enough that you can act while the property still has value. That single clause is the difference between having a remedy at month 26 and having one at month 40 when the equity is gone.

Third, the exit cap is the assumption carrying the whole position, so buy protection against it rather than betting on it. That's the 1.30x versus 1.35x argument, and it's also why I'd want the accrual to compound and to sit on top of unreturned capital in the document, because that's the piece that grows if the exit slips.

Fourth, confirm the senior permits the pref and will sign something recognizing your right to replace the managing member. If they won't, you're pricing an unsecured position with consent rights and 82% last dollar, which is a different instrument than the one on your term sheet. How the pledge and any transfer restriction actually work varies by the state of formation, so get a lawyer who does these to walk the remedy path start to finish before you agree on price.

On the question you actually asked, funding your own current pay is fine when the reserve outlives the crossover under stress. Here it doesn't obviously do that, and that's what I'd trade the extra point for.

Canton's second point is the one I'd have missed entirely. The cure period being long is functionally the same as having no default.

Worth clarifying the vocabulary here. When people say the pref gets wiped out before the senior takes a loss, that means at 82 percent last dollar, a 20 percent value decline takes all of the pref position and the senior is still whole at 66 percent. That's a much smaller move than it first appears to be.

Vellum, the order is right, the size isn't. 82% last dollar means an 18% decline is roughly where you start losing money, not where you're gone. $34M less 18% is $27.88M, the senior takes its $22.4M, and $5.48M of your $5.6M is still there. You're at zero only when value falls to the senior's balance of $22.4M, a 34% drop. What should bother you instead is that the top of your position moves up while you hold it, so by month 36 the cushion under you is nearer 15% than 18%.

The number worth arguing with is the $1.72M NOI. A 5.06% cap on 1980s value-add stock in a secondary market implies the buyer is paying for the plan, not the income, which can be reasonable, but that same $34M is also the denominator of the 82% coverage figure. If a lender's appraisal came in at $32M instead, the last dollar moves to 87.5% and the whole conversation changes. Is the $34M an appraisal in hand or the sponsor's basis plus capex? And separately, what does the tax bill do after a sale or recapitalization in that county, since a reassessment on a fresh transaction has eaten more NOI ramps than bad leasing has.

In the document, find how the reserve is held and whose account it is in. Some deals structure the interest reserve sitting in an operating account controlled by the manager with a covenant not to use it for anything else, which is worth roughly nothing when the manager needs $200k in a hurry. A controlled account with the pref holder's signature required on withdrawals is what makes it a reserve; anything less is not. Also check whether the reserve counts as returned capital for purposes of the minimum multiple. If drawing $1.1M back reduces unreturned capital, the multiple is calculated on a shrinking base, and real dollars get lost to a definition.

Fathom's second point is the sharpest thing in the thread. That ambiguity between the definition of unreturned capital and payments made from a funded reserve shows up often, and both readings are defensible from the same draft. Get it stated explicitly that reserve-funded current pay is treated as a distribution of the preferred return and does not reduce unreturned capital, or the other way if that's what gets agreed, but say which.

This thread has done more for how I think about capital stacks than the last three chapters I read. The pattern I'm taking is that the coupon is the least negotiable-looking number and the least important one.