The pref redemption date sat inside my senior lockout, which cost me the promote

Writing this from the sponsor side. Mid-size industrial infill, five buildings, $14.2m purchase. Senior loan was $9.1m fixed for five years with defeasance and a lockout through year four. I needed another $2.6m to close and my common equity was tapped, so I took pref at 13%, 6% current, redemption date at month 36 with a step to 18% if unredeemed.

My plan on paper was refinance at month 34 into the stabilized value and pay the pref out. I never seriously stress tested what happens if the refinance isn't available at month 34, because the exit cap I used made the numbers work and I wanted the deal.

At month 30 the new-loan quotes were roughly 175 basis points above my existing coupon and the proceeds came out about $1.9m short of paying off the senior plus the pref. Paying the senior off early meant defeasance costs I hadn't reserved for. Holding meant the pref rate stepping to 18% on an accrued balance that was already compounding, on a property throwing off enough for 6% current and not much else.

I sold at month 38 into a bid environment that was not kind. Senior got paid, pref got its multiple, my $1.4m of common equity came back as $210k and the promote was gone. Nobody defaulted, nobody sued, the structure worked exactly as written.

What I'd do differently: the pref redemption date has to sit outside the senior's prepayment restriction, with room. If a pref provider insists on month 36 against a five year lockout, that's a signal about who's supposed to end up owning the deal. I'd also want an extension option I control, priced up front, even at a cost I hate.

2 replies

2omar_haddadActivePRO11

The step to 18% on an accruing balance is the part that turns a slow problem into a fast one. Same shape as a job where the schedule slips and the escalation clause is annual, right up until it isn't.

keystone, was the extension even on the table at closing? Every pref term sheet I've seen has one written somewhere, usually a six or twelve month bump for a fee plus a rate increase, and it's always conditioned on something like a minimum debt yield you can't hit by the time you need it. Conditions you can't control aren't options.

1renee_dubois Get yours

The line about wanting the deal is the honest one, and I've done the same thing at much smaller scale with a seller carry. I forced the exit cap until the spreadsheet agreed with me.

One thing I'd add for anyone reading. The mismatch you're describing isn't only about dates lining up, it's about the two pieces of capital having different opinions about time. Your senior lender is paid to keep you in place for five years. Your pref is paid to get out in three and gets paid more if it can't. There isn't a version where both of those things are satisfied by the same operating plan, so somebody has to have a documented answer for month 36 before anyone funds. Mine now is that pref redemption lands at least a year after prepayment opens and I hold a reserve sized to the defeasance estimate rather than to zero.

The pref redemption date sat inside my senior lockout, which cost me the promote

2 replies