Pref at the property JV or at the holdco? Does that survive a bad month?

Question

Working through a recap where the sponsor has offered me a choice on where the pref sits and I want to hear the room argue it before I decide.

Option one, I come in as a preferred member of the property-owning LLC itself, directly above common in that entity's waterfall. Option two, I sit in a holding company that owns 100% of the property LLC, with the pref rights at that upper level and a pledge of the holdco's membership interest.

Neither creates a lien on the real estate, so I'm not comparing a foreclosure to a non-foreclosure. What differs is what I can reach and how fast. At the property level I'm inside the borrower, which means the senior loan documents and the SPE covenants apply to me directly. Transfer restrictions, the single-purpose entity requirements, the whole thing. I'm visible to the lender and constrained by them, and in exchange my priority sits in the same waterfall as the cash.

Up at the holdco I'm outside the borrower's SPE fence and structurally further from the property, but my remedies can be exercised without touching the mortgage borrower's ownership on paper, which sometimes avoids tripping the change of control provision. I've also heard the argument that a holdco pledge starts to look like mezz debt in substance and gets treated that way in a fight, which would be a question for counsel in the relevant state since it turns on how a court characterizes the instrument.

Sponsor is indifferent, or says he is. His senior lender may not be. Where do you sit and why.

chriswalton8 · Accepted Answer

I'd take the property JV level, and the reason is cash rather than remedies.

Everything above the property LLC only receives what the property LLC distributes. If you're at the holdco, your priority is a claim on distributions that a manager has to declare and send upstairs. At the property level your preferred return sits in the same waterfall as the operating cash, ahead of common, and the accounting for it is being done in the same set of books as the rent. In slow deals the fight is almost never about who has the better remedy on paper. It's about whether money leaves the property or gets absorbed in fees, reserves and affiliate payments before it ever reaches the entity you're a member of.

On your change-of-control point, I'd test it rather than accept it. Plenty of senior loan documents define control at the ultimate beneficial ownership level, which means a shift up at the holdco trips exactly the same provision as one at the borrower. Have counsel read the transfer section of the actual loan agreement, not the term sheet summary, and note that how these provisions get enforced can vary by state and by lender, so you'd want the lender's written position before funding either way.

The holdco version earns its keep when there are multiple properties under one roof and you want cross-collateralized priority across all of them. For a single asset recap I don't see what it buys you that offsets the extra distance from the money.

What's the senior loan's SPE language say about admitting new members? That may make the decision for you.

monica_tran3 · Answer

sable's point about affiliate payments is the one I'd hammer. Cash gets eaten before it goes upstairs, every time, and always for a defensible-sounding reason.

Pref at the property JV or at the holdco? Does that survive a bad month?

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