A preferred equity transaction, just like a mortgage loan transaction, has typical costs associated with it. Many of these costs mirror those found in a mortgage loan, as well. Though every transaction is different, the most common costs associated with preferred equity are explored here.
Third Party Reports
Typically, the senior lender bears the cost for engaging vendors to complete standard third-party reports as part of its loan transaction process. These most often include an appraisal, some type of background or credit check, an environmental report, a property condition report and a zoning report. Preferred equity providers generally obtain reliance on those reports rather than commission new reports, which leads to lower costs for the sponsor. In some instances, such as a recapitalization without a refinance of the senior mortgage loan, the preferred equity provider will have to order some or all those third-party reports.
The preferred equity provider often will travel to the property as part of its diligence; the costs associated with the site visit are then charged to the sponsor as part of the transaction. These costs typically include any air travel, vehicle rental, food, or hotel charges that the preferred equity provider incurs during the site visit. Preferred equity providers strive to keep these costs as low as possible in order to save the sponsor money in the transaction.
Most preferred equity transactions will include a fee charged by the preferred equity provider to originate the transaction. Typically, this is some percentage of the total preferred equity investment. Similarly, senior lenders frequently charge some type of origination fee that is a percentage of that senior loan amount.
The preferred equity provider may charge an underwriting fee that is deemed earned upon receiving a fully-executed term sheet and expense deposit. In the event that the transaction does not close, this underwriting fee would not be returned to the sponsor.
Every preferred equity transaction will involve the preferred equity provider’s legal counsel. This cost may include more than one firm; for instance, the preferred equity provider will have an attorney who drafts the legal documents governing the transaction, interfaces with the sponsor’s counsel, senior lender’s counsel and agency counsel and reviews legal documents produced by those attorneys.
Depending on the regulations governing the preferred equity provider, there may also be tax counsel who advise the preferred equity provider on matters relating to how the investment may be taxed or represented in its financials. Not all preferred equity providers pass this cost directly to the sponsor on a per-transaction basis, but it is not unusual to see it in a preferred equity transaction.
What It All Means
The typical costs found in a preferred equity transaction generally include expenses associated with collecting diligence items such as third-party reports and site visits to the property as well as several fees associated with initiating and completing the transaction. Most of these costs may be deducted from the initial deposit the sponsor made along with the executed term sheet.
Sponsors should expect to see most of these costs in any preferred equity transaction, though every preferred equity provider will strive to keep these costs as low as possible during the transaction in order to maximize the amount it funds at closing.