What Is A Preferred Return For Investors?

In real estate, a preferred return is a portion of the profit distribution that an investor must get before the general partners are paid. Depending on the risk of the investment, a return on real estate is typically preferred to be between 6 and 9%. This percentage is established before the deal is presented to potential investors.

Example of Preferred Return #1:

The sponsor did not reach the 8% preferred return because distributions paid out at 7%, and the preferred return was 8%. A 1% deficit exists; this amount has been accrued and will be returned to investors the following year. Before the sponsor receives any returns, the investor will receive the standard 8% preferred return plus the 1% return from year one in year two of the investment project. With this structure, the deal sponsor or syndicator is incentivized to make the property produce cash flow since the preferred return must be paid out to the deal’s investors first.

Example of Preferred Return #2:

Let’s say that the project’s preferred return is still 8%, but the asset is paying out distributions at 14%. The sponsor has now exceeded the preferred return of 8%. In this scenario, after the investors get paid the 8% preferred return, there is now a 6% remainder after paying out the 8% preferred return. For a deal with a 75/25 split, 75% of any excess distributions go to the investor, and only 25% will go to the sponsor. The preferred return provides investors with a level of safety and confidence within their real estate investment.

Why Are Real Estate Investors Focused On The Preferred Return?

If you’re reading this, you either invest in real estate already or are interested in learning more about it. To be in the position to get the best returns from your real estate investments, it is essential to understand preferred returns in private real estate investment packages.

An investor that contributes their own money to a real estate syndication to help purchase a real estate property will receive a preferred return. The preferred return, typically between 6 and 9 percent, is decided upon before the contract is presented to prospective passive investors.

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