The pref investor who read the waterfall wrong and the sponsor who wrote it wrong can share the same document
A deal worth studying: a 72-unit value-add, $1.8 million pref tranche sitting at a 14 percent preferred return, with a redemption date set at month 36. The pref documents defined the return as compounding on unpaid amounts, which is standard. What the sponsor treated as standard was a cash-pay obligation only when operations supported it, with the remainder accruing. What the pref investor read was a 14 percent cash-pay position with accrual as a temporary accommodation. Same document, two readings, and neither party flagged the conflict at closing because the deal was projecting enough cash flow to make the distinction feel academic. Then year one NOI came in at 78 percent of pro forma. The accrual balance grew. At month 30 the redemption math had the pref owed $2.24 million on a property whose refreshed valuation supported roughly $1.95 million in total debt and equity recovery after the senior was satisfied. The removal rights in the pref docs required a payment default of 90 days, not an accrual shortfall. So the investor held a position that was economically underwater, legally current, and practically unreachable. The sentence that caused it read: "preferred return shall accrue on any unpaid current pay amounts and shall be paid from available cash flow prior to any distributions to common equity." Both parties thought that sentence described their version of the deal. The word "available" did all the work, and nobody defined it.
When you are reviewing a pref term sheet, what does your counsel treat as the threshold question on cash-pay versus accrual, and does your sponsor answer it before or after you ask?
