Preferred and common equity are both forms of ownership in a real estate project, but they differ in their rights and priorities. Preferred equity has payment priority when distributions are made or a capital event occurs. However, it also carries a target fixed rate of return. Conversely, common equity offers the potential for outsized returns and uncapped gains, but it resides in the most subordinate position in the capital stack for distributions and capital events.

Traditional lending sources typically provide a senior mortgage on property up to 75% of the asset’s value. Consequently, real estate owners and developers turn to preferred and common equity to complete the remaining balance of the capital stack. Understanding the nuances of each investment and its respective position in the capital stack is essential.

Preferred Equity

Preferred equity investments are in a junior position behind the first mortgage but are in a senior position to the sponsor’s equity investment, often referred to as common equity. For example, when net cash flow is generated from a property or profits are earned upon a capital event, preferred equity investors receive distributions after the senior lender, but before the common equity. Since preferred equity is subordinate to the senior mortgage, it carries a higher degree of risk and warrants a higher rate of return than the interest rate charged on the first mortgage.

Preferred equity can be structured in many ways, but usually involves a target fixed rate of return that is satisfied through a pay rate and an accrual rate.  The pay rate refers to the portion of the total return that is paid out regularly, typically from cash flow. The accrual rate represents the portion that is not paid out regularly and instead accumulates until a capital event. The sum of the pay rate and the accrual rate equals the total preferred return.

The returns of preferred equity investors are typically capped depending on the deal structure, so the common equity can reap most, if not all, of the profits after the preferred equity investors are paid. These investors are willing to cap their upside by aiming for a more secure position in the capital stack. 

Common Equity

In contrast to preferred equity, common equity holds the most junior position in the capital stack. These investors accept the most risk and are only paid after all other parties in the capital stack receive their entitled funds. However, they also have the greatest upside and potential for substantial returns if an investment thrives, because they have rights to all income left after everyone else gets paid.

The common equity ownership structure typically consists of a limited partner (LP) and a general partner (GP) or sponsor, with a predetermined financial framework in place before they acquire the asset. This framework outlines how profits from an investment are distributed to different investors. It’s designed to align the incentives of all parties involved, ensuring that specific investors are repaid their initial investment and receive a preferred return before others receive their share of the profits.

Conclusion

The most significant difference between preferred and common equity is the repayment priority, based on where each type resides in the capital stack. Preferred equity offers attractive features: payment priority over common equity, fixed preferred returns, and generally stable cash flows. However, being a common equity investor also provides several potential benefits despite being in the most subordinated position of the capital stack. These benefits include the potential for outsized returns, no cap on return potential or gains, and tax benefits. Common equity investments offer passive income and the potential to build generational wealth when invested alongside a proven sponsor.

Disclaimer: This document is for informational purposes only and is not financial, legal, or investment advice, nor an offer or solicitation to buy or sell securities. Investment opportunities offered by Bam Capital are made pursuant to Rule 506(c) of Regulation D and are available exclusively to accredited investors, as defined by the Securities and Exchange Commission (SEC). Verification of accredited investor status is required before participation in any investment. The information contained herein reflects the opinions of the author and does not necessarily represent the views of Bam Capital. Any financial terms, projections, or forward-looking statements contained herein are hypothetical in nature and should not be interpreted as guarantees of future performance or safety. Such statements reflect opinions and are subject to market fluctuations, economic conditions, and investment risks. Investing in private real estate securities involves significant risks, including but not limited to illiquidity, economic downturns, and potential loss of invested funds. Past performance does not guarantee future results. Prospective investors are strongly encouraged to conduct independent due diligence and consult with legal, tax, and financial advisors before making any investment decisions. Bam Capital makes no representation or warranty regarding the accuracy or completeness of the information contained herein.
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Author: Tony Landa, Senior Economic Advisor, The BAM Companies, July 2025