Preferred Equity Gap Financing
Reducing sponsor equity contribution by 40% on a stabilized multifamily acquisition.
Deal Overview
| Property | 142-unit garden-style apartment community |
| Location | Richmond, Virginia |
| Strategy | Stabilized acquisition with capital optimization |
| Total Capitalization | $18.5M |
| Preferred Equity | $2.2M |
The Situation
An experienced multifamily sponsor identified an attractive acquisition opportunity—a well-maintained, 142-unit apartment community in a growing Richmond submarket. The property was 94% occupied with stable cash flow and qualified for Fannie Mae permanent financing.
The sponsor had the capital to close but saw an opportunity to optimize their capital deployment across multiple deals rather than concentrating equity in a single asset.
The challenge: Agency lenders (Fannie/Freddie) generally restrict subordinate debt—meaning traditional mezzanine financing wasn't permitted. The sponsor needed a capital solution that would satisfy agency requirements while reducing their equity commitment.
The Challenges
Agency restrictions
Fannie Mae loan prohibited subordinate debt or additional liens
Capital efficiency goals
Sponsor wanted to deploy equity across 3 acquisitions, not concentrate in one
Return targets
Reducing equity couldn't come at a cost that destroyed deal economics
Control preservation
Sponsor needed to maintain operational control and promote structure
Our Approach
Brookmont structured a preferred equity solution that satisfied all requirements:
1. Preferred Equity (Not Debt)
Preferred equity is structured as an investment in the ownership entity—not a loan secured by the property. This distinction allows it to work alongside agency senior debt without violating subordinate debt restrictions.
2. Institutional Investor Match
We connected the sponsor with a family office seeking preferred equity investments with current-pay returns and downside protection.
3. Balanced Terms
We negotiated terms that provided the preferred investor with adequate return while preserving sponsor economics and control.
The Capital Structure
| Purchase Price | $17,800,000 |
| Closing Costs & Reserves | $700,000 |
| Total Capitalization | $18,500,000 |
| Source | Amount | % of Cap |
|---|---|---|
| Fannie Mae Senior Debt | $13,350,000 | 72% |
| Preferred Equity | $2,200,000 | 12% |
| Sponsor Common Equity | $2,950,000 | 16% |
Equity Reduction Impact
Without Preferred Equity:
Required Sponsor Equity: $5,150,000 (28% of cap)
With Preferred Equity:
Required Sponsor Equity: $2,950,000 (16% of cap)
Equity Reduction: 43%
The Economics
| Effective Gross Income | $2,180,000 |
| Operating Expenses | $870,000 |
| Net Operating Income | $1,310,000 |
| Senior Debt Service | $924,000 |
| Preferred Return (11%) | $242,000 |
| Cash to Common Equity | $144,000 |
Sponsor Returns Comparison
| Metric | Without Pref | With Pref |
|---|---|---|
| Equity Invested | $5,150,000 | $2,950,000 |
| Annual Cash Flow | $386,000 | $144,000 |
| Cash-on-Cash Return | 7.5% | 4.9% |
| IRR (5-year, 4% cap exit) | 14.2% | 18.7% |
While annual cash flow is lower with preferred equity, the significantly reduced equity base increases the sponsor's IRR from 14.2% to 18.7% over a 5-year hold.
The Outcome
Capital Efficiency Achieved
The sponsor used the $2.2M in preserved equity to fund down payments on two additional acquisitions—ultimately controlling three assets totaling $48M in value rather than one $18M property.
| Metric | Single Deal | Three-Deal Strategy |
|---|---|---|
| Total Equity Deployed | $5,150,000 | $5,150,000 |
| Total Asset Value | $18,500,000 | $48,200,000 |
| Total Equity Multiple (proj) | 1.45x | 1.52x |
| Diversification | 1 market | 3 markets |
Key Takeaways
1. Preferred equity works with agency debt
Unlike mezzanine loans, properly structured preferred equity satisfies Fannie/Freddie requirements for multifamily acquisitions.
2. Capital efficiency drives portfolio returns
Reducing per-deal equity allows sponsors to diversify across more assets, reducing concentration risk while potentially improving overall returns.
3. IRR vs. cash flow trade-off
Preferred equity reduces current cash flow but improves IRR through reduced equity basis. The right structure depends on sponsor objectives.
4. Control can be preserved
With negotiated approval rights limited to major decisions, sponsors maintain day-to-day operational control while bringing in preferred capital.
This case study represents a representative transaction. Specific details have been modified to protect client confidentiality.