What is a Preferred Return in Real Estate?
There are many ways to slice and dice a multi family real estate deal and this can cause confusion to many real estate investors. In this blog we will define the preferred return, provide you a reference to a typical preferred return split, and show you the safety preferred returns can provide to real estate investors!
Back To Basics | Preferred Return Defined
The term preferred is defined as to put forward or advance. In multi family real estate the preferred return refers to the ordering in which profits are distributed to investors or in other words, the investors return is put first over a syndicator or deal sponsor (the person putting the real estate investment together). Preferred returns are most commonly used in real estate investments.
Here’s An Example of a Preferred Return!
In most multi family real estate deal structures, preferred returns will range from 7-12%. In the video above we provide an example of Jim who received a 7% preferred return with a 30% split to sponsors after the preferred return has been paid.
In reference to this deal structure, if Jim had invested $100,000, it meant that each year, Jim would receive a 7% return, or $7,000 first, before the real estate syndicator took a single dollar for their split. After Jim has been paid the 7% preferred return, the remaining net gains will be split with the syndicators, where investors take 70% and syndicators take 30%. This is a basic example of a preferred return in a multi family real estate deal.
Why are Preferred Returns Important?
Whether you are a real estate syndicator or a passive real estate investor, preferred returns build trust and accountability. As a syndicator implementing preferred returns in your investment opportunities shows your investors that the investment is expected to not only reach the preferred return but exceed it! This provides protection to investors and displays the confidence of a real estate syndicator in his or her investment opportunity.
A preferred return is also powerful because it is accrued, meaning that if the economy is down and the investment is not able to pay it’s preferred return for the year, the remaining percentage of preferred return is owed to investors before syndicators can get paid!
Whether you are looking to become a syndicator or invest in multi family real estate passively, we recommend preferred returns to build trust, accountability, and protection to investors.
Video Transcription
This is David David is looking to invest in real estate but has come across a term that he is unfamiliar with. Preferred Return. David seeks out help from his friend Jim who has been investing in multifamily real estate for many years! Jim tells david that is awesome news, because a preferred return adds extra protection for investors! Jim gives David an example of preferred return from his first multifamily investment. Jim says the preferred return of his first deal was 7% with a 30% split to sponsors after the preferred return was paid. In that deal, Jim had invested $100,000. That meant that each year,Jim got 7% return, or $7,000 first, before the sponsors took a single dollar for their split! After Jim was paid 7%, the remaining net gains were split with the sponsors, where investors took 70% and sponsors took 30%. Jim tells David that a preferred return builds accountability from the sponsor team and allows management to show its investors that the property is expected to not only reach the preferred return but exceed it! A preferred return is a powerful because it is accrued, meaning that if the economy is down and the property is only able to pay out 5% to investors that year, the remaining 2% are still owed to the investors, and they must be paid before the sponsors can get paid! David is excited because he now understands the importance of a preferred return on investment deals, and why it’s a powerful tool to help protect investors.