Preferred equity sits above common equity in the capital stack and receives a priority return (10-18%) before common equity holders receive any distributions. Common equity is the last money in and first money lost — it bears the highest risk but captures all remaining upside after debt service, preferred returns, and promote distributions. Preferred equity offers downside protection through its priority position; common equity offers unlimited upside.
Quick Comparison
Key attributes side by side.
| Attribute | Preferred Equity | Common Equity |
|---|---|---|
| Position in Capital Stack | Above common equity, below all debt | Top of the stack — highest risk position |
| Security / Collateral | No lien; priority return per operating agreement | No lien; residual claim after all other obligations |
| Typical Term | 2-5 years or aligned with deal hold period | Life of the deal (3-7+ years) |
| Cost / Rate Range | 10-18% preferred return + potential equity kicker | Target IRR of 15-25%+ depending on risk and strategy |
| Risk Profile | Moderate — priority return provides downside cushion | Highest — first to absorb losses, last to be repaid |
| When to Use | When you want a fixed-priority return with some downside protection | When you want maximum upside and are willing to take the most risk |
| Foreclosure / Remedy | Operating agreement remedies: forced sale, management replacement | No specific remedy — bears all residual risk |
In Depth
Preferred equity is an investment that sits between debt and common equity in the capital stack. The preferred equity investor contributes capital to the deal and receives a priority return — a fixed percentage (typically 10-18%) paid before any distributions flow to common equity holders. This priority position provides meaningful downside protection compared to common equity.
Preferred equity investors may also negotiate an "equity kicker" — a share of profits above the preferred return. For example, a preferred equity investor might receive a 12% preferred return plus 10% of profits above a 12% IRR hurdle. This structure gives the preferred investor some upside while maintaining their priority position.
The risks of preferred equity are real but more limited than common equity. If the deal underperforms significantly, the preferred equity investor may not receive their full preferred return, and in a severe downturn, they could lose principal. However, common equity absorbs losses first, providing a cushion. Preferred equity is often used by investors who want CRE exposure with more predictable, bond-like returns.
In Depth
Common equity represents the ownership interest at the very top of the capital stack. Common equity investors — typically the sponsor/GP and their limited partners — bear the most risk in the deal. They are last to receive distributions (after debt service and preferred returns) and first to absorb losses if the property underperforms.
In exchange for bearing the highest risk, common equity investors capture all the remaining upside. Once debt obligations and preferred returns are satisfied, all remaining cash flow and appreciation accrue to common equity. In a successful deal, common equity returns can significantly exceed 20-30% IRR, far outpacing the fixed returns earned by debt and preferred equity investors.
Common equity is typically structured through a waterfall with a preferred return to LPs (6-10%), followed by a promote split to the GP (20-40% of profits above the hurdle). The GP's promote represents the highest-returning position in the entire capital stack — but only if the deal performs well. If the deal underperforms, common equity investors bear all the losses before any other capital stack participant is affected.
Key Differences
Payment priority: Preferred equity receives distributions before common equity; common equity is last.
Loss absorption: Common equity absorbs losses first; preferred equity is impaired only after common equity is wiped out.
Return profile: Preferred equity earns a fixed priority return (10-18%); common equity targets higher but variable returns (15-25%+ IRR).
Upside: Preferred equity has capped or limited upside; common equity has unlimited upside potential.
Control: Common equity (GP) controls the deal; preferred equity investors typically have protective rights but not operating control.
Risk tolerance: Preferred equity suits investors seeking more predictable returns; common equity suits those with higher risk tolerance.
Exit: Preferred equity is often redeemed at a fixed date; common equity exits when the property is sold or refinanced.
Decision Guide
Practical scenarios to help you decide.
Our Role
H Equities provides preferred equity investments ($3MM-$15MM) for commercial real estate transactions. As a preferred equity investor, we bring institutional capital with fair terms and flexible structuring. For sponsors, our preferred equity reduces the common equity requirement while providing certainty of capital.
FAQ
Yes, generally. Preferred equity sits below common equity in the loss absorption order, meaning common equity absorbs losses first. However, preferred equity is still equity — it is riskier than any form of debt in the capital stack and can lose principal in severe downturns.
Yes, but only if the property loses so much value that common equity is fully wiped out and losses continue into the preferred equity position. In practice, preferred equity losses require significant property value declines beyond the common equity cushion.
An equity kicker is additional profit participation granted to a preferred equity investor above their stated preferred return. For example, a preferred equity investor might receive 12% preferred return plus 10% of profits above a 15% IRR hurdle. This sweetens the deal for the preferred investor.
A waterfall defines the order in which profits are distributed: first to debt service, then preferred equity returns, then LP preferred returns, and finally the promote split between GP and LPs. Each tier must be satisfied before cash flows to the next level.
Preferred equity does not create a debt obligation or require an intercreditor agreement. It is treated as equity by senior lenders, so it does not violate loan covenants. For sponsors with agency or CMBS debt that prohibits subordinate financing, preferred equity may be the only way to fill the capital gap.
Related
Tell us about your transaction and we'll help you identify the right financing structure — bridge, mezzanine, preferred equity, or co-GP.