Section 1602

Preferred Equity

1602.01

Description
1602.01A

Definitions

Requirements

Preferred Equity is an equity investment in an entity where the holder is entitled to preferred dividends, distributions, payments, or returns relative to the other equity owners.

Fannie Mae defines 2 types of Preferred Equity.

Type

Definition

Soft Preferred Equity

Preferred Equity that:

 

  • only requires preferred payments or returns to the holder if cash flow from the PropertyPropertyMultifamily residential real estate securing the Mortgage Loan, including the fee simple or Leasehold interest, Improvements, and personal property (per the Uniform Commercial Code). is sufficient to make the payments or returns after satisfying the payment, reserve, escrow, and funding obligations of the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. and all PropertyPropertyMultifamily residential real estate securing the Mortgage Loan, including the fee simple or Leasehold interest, Improvements, and personal property (per the Uniform Commercial Code). operating expenses;
  • has organizational documents that explicitly state that the preferred return may accrue if cash flow from operations is insufficient to pay the return; and
  • does not have a maturity date, redemption date, trigger date, or require repayment during the term of the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. .

Hard Preferred Equity

Preferred Equity that requires preferred payments or returns to the holder, regardless of whether cash flow from the PropertyPropertyMultifamily residential real estate securing the Mortgage Loan, including the fee simple or Leasehold interest, Improvements, and personal property (per the Uniform Commercial Code). is sufficient to make the payments or returns.
1602.01B

Exclusions

Guidance

This Section does not apply to:

  • Soft Preferred Equity that does not benefit from any remedial rights related to the failure to make or pay any preferred payment of return; or
  • any BorrowerBorrowerPerson who is the obligor per the Note. organizational or capital structures relating solely to the allocation of LIHTCsLIHTCsFederal program offering tax credits to owners of eligible properties that contain low-income occupants and rent restrictions. .

For example, Part III, Chapter 16: Mezzanine Financing and Preferred Equity, Section 1602: Preferred Equity does not apply to:

  • Soft Preferred Equity that is Preferred Equity only because of “promoted interest” or priority “waterfall” distributions in the organizational structure of the BorrowerBorrowerPerson who is the obligor per the Note. , but does not otherwise benefit from remedial rights when distributions are not paid or made.
  • Instances where a provision in the Borrower’sBorrower’sPerson who is the obligor per the Note. organizational documents allows or requires a forced sale of the PropertyPropertyMultifamily residential real estate securing the Mortgage Loan, including the fee simple or Leasehold interest, Improvements, and personal property (per the Uniform Commercial Code). to a third party in an arm’s length transaction
    • if preferred payments or returns are not made, or
    • for standard non-recourse guaranties.
1602.01C

Eligible Mortgage Loans

Requirements

Mortgage LoansMortgage LoansMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. with Preferred Equity structures must:

  • be newly originated;
  • be fixed rate; and
  • for Hard Preferred Equity,
    • have an original principal balance of at least $10 million, and
    • be flagged for MBSMBSMortgage-Backed Security additional disclosure per Form 4098.
1602.01D

Structures

Guidance

Preferred Equity may be structured in a variety of ways, and appear similar to a traditional equity investment, while having rights or remedies similar to debt, such as Mezzanine FinancingMezzanine FinancingSubordinate debt financing provided to a direct or indirect owner of a Borrower that is secured by a pledge of the direct or indirect equity interest in the Borrower held by the owner, and not by a Lien on the Property. .

To determine if the Preferred Equity is Soft or Hard, you should analyze the:

  • Borrower’sBorrower’sPerson who is the obligor per the Note. organizational and capital structure;
  • Borrower’sBorrower’sPerson who is the obligor per the Note. applicable joint venture or operating agreement with the Preferred Equity provider; and
  • rights and remedies of the direct and indirect equity owners against the BorrowerBorrowerPerson who is the obligor per the Note. .
1602.01E

Limitations

Requirements

Preferred Equity must:

  • not have a maturity date, redemption date, trigger date, or require repayment during the term of the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. ;
  • have a fixed rate of return without escalations during the term of the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. ;
  • not include cash flow sweeps above the stated return;
  • not be cross-collateralized with multiple assets;
  • for a deal that has both a Hard Preferred Equity return and Soft Preferred Equity return, be underwritten using the total combined preferred return to calculate the DSCRDSCROn an annual basis or any specified period, the ratio of Net Cash Flow to the total of:  principal, interest, and required Mezzanine Financing or Hard Preferred Equity payments. per Form 4660;
  • not have intercreditor or recognition agreements between you and the Preferred Equity holder; all rights of the Preferred Equity holder that you recognize must be contained in the Loan DocumentsLoan DocumentsAll Fannie Mae-approved documents evidencing, securing, or guaranteeing the Mortgage Loan. ;
  • not have side letters; all information, terms, and conditions relating to the Preferred Equity must be contained in the organizational documents; and
  • for Hard Preferred Equity, not be less than $1 million.

You must underwrite the Preferred Equity as Hard Preferred Equity, if any of the following apply:

  • the organizational documents do not explicitly state that the preferred return may accrue if cash flow from operations is insufficient to pay the preferred return;
  • there are remedies associated with operating benchmarks such as NCFNCFOn an annual basis or any specified period, the total Net Operating Income, minus the full amount underwritten for Replacement Reserve expense, regardless of whether deposits will be made (per Part II, Chapter 2: Valuation and Income, Section 203: Income Analysis and the applicable products and…, NOINOIAnnually or for any specified period, the total Effective Gross Income minus the Property’s operating expenses. , or other operating thresholds;
  • there are reserves to ensure the payment of the preferred return; or
  • the holder of Preferred Equity benefits from a
    • pledge of the general partner’s or managing member’s interest in the BorrowerBorrowerPerson who is the obligor per the Note. , or any direct or indirect owner of the BorrowerBorrowerPerson who is the obligor per the Note. , or
    • guaranty or indemnity from the general partner, managing member, or manager of the BorrowerBorrowerPerson who is the obligor per the Note. (or any parent or other PersonPersonLegal person, including an individual, estate, trust, corporation, partnership, limited liability company, financial institution, joint venture, association, or other organization or entity (whether governmental or private). ControllingControllingPossessing, directly or indirectly, the power to direct or cause the management and operations of an entity (e.g., through the ownership of voting securities or other ownership interests, or by contract). any of them) with respect to the preferred payment or returns.  If a guaranty or indemnity is executed by the Key PrincipalKey PrincipalPerson who controls and/or manages the Borrower or the Property, is critical to the successful operation and management of the Borrower and the Property, and/or may be required to provide a Guaranty. executing a GuarantyGuarantyPayment Guaranty, Non-Recourse Guaranty, or other guaranty by a Guarantor for the Mortgage Loan. for the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. , the guaranty or indemnity of the preferred payment or returns must be expressly subordinate to the GuarantyGuarantyPayment Guaranty, Non-Recourse Guaranty, or other guaranty by a Guarantor for the Mortgage Loan. for the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. .
1602.01F

Lender's Loan Application

Requirements

Your loan application form must:

  • require the BorrowerBorrowerPerson who is the obligor per the Note. to indicate whether it has or intends to obtain Preferred Equity as part of its organizational or capital structure; and
  • inform the BorrowerBorrowerPerson who is the obligor per the Note. that you may delay approval or revoke any prior approval if the BorrowerBorrowerPerson who is the obligor per the Note. changes its intention to obtain Mezzanine FinancingMezzanine FinancingSubordinate debt financing provided to a direct or indirect owner of a Borrower that is secured by a pledge of the direct or indirect equity interest in the Borrower held by the owner, and not by a Lien on the Property. .
1602.02

Underwriting

Requirements

For any Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. with Preferred Equity, you must comply with the following table.

Topic

Requirements

Guaranty

If the holder of the Preferred Equity benefits from a guaranty or similar indemnity that contains recourse events or similar obligations not otherwise contained in the Loan DocumentsLoan DocumentsAll Fannie Mae-approved documents evidencing, securing, or guaranteeing the Mortgage Loan. , you must

 

  • submit the modifications to Fannie Mae for review and approval, and
  • if approved by Fannie Mae, add the events or obligations to the appropriate Loan DocumentLoan DocumentAll Fannie Mae-approved documents evidencing, securing, or guaranteeing the Mortgage Loan. .

Refinance Analysis

Prepare a refinance analysis that:

 

  • incorporates the terms of both the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. and the Preferred Equity;
  • demonstrates that the BorrowerBorrowerPerson who is the obligor per the Note. will
    • maintain a positive equity position in the PropertyPropertyMultifamily residential real estate securing the Mortgage Loan, including the fee simple or Leasehold interest, Improvements, and personal property (per the Uniform Commercial Code). throughout the term of the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. , or
    • have some other incentive (e.g., continuing cash flow) to remain committed to the PropertyPropertyMultifamily residential real estate securing the Mortgage Loan, including the fee simple or Leasehold interest, Improvements, and personal property (per the Uniform Commercial Code). and its successful operation; and
  • concludes that there will be sufficient cash flow, NCFNCFOn an annual basis or any specified period, the total Net Operating Income, minus the full amount underwritten for Replacement Reserve expense, regardless of whether deposits will be made (per Part II, Chapter 2: Valuation and Income, Section 203: Income Analysis and the applicable products and… growth, and residual value to pay off the Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. and the Preferred Equity (if applicable) at maturity.

Replacement Guarantor

Identify an acceptable replacement guarantor that complies with the GuideGuideMultifamily Selling and Servicing Guide controlling all Lender and Servicer requirements unless a Lender Contract specifies otherwise. for Key PrincipalsKey PrincipalsPerson who controls and/or manages the Borrower or the Property, is critical to the successful operation and management of the Borrower and the Property, and/or may be required to provide a Guaranty. for any Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. with

 

  • Hard Preferred Equity, and
  • Soft Preferred Equity if modifications to the transfer provisions of the Loan DocumentsLoan DocumentsAll Fannie Mae-approved documents evidencing, securing, or guaranteeing the Mortgage Loan. are requested for the benefit of the Soft Preferred Equity holder.

Loan Documents

Use the Loan DocumentsLoan DocumentsAll Fannie Mae-approved documents evidencing, securing, or guaranteeing the Mortgage Loan. for Preferred Equity per the Loan Documentation RequirementsLoan Documentation RequirementsLoan Documents listed in Form 6000 applicable to the particular Mortgage Loan execution and/or product and features. (Form 6000) for any Mortgage LoanMortgage LoanMortgage debt obligation evidenced, or when made will be evidenced, by the Loan Documents, or  a mortgage debt obligation with a Fannie Mae credit enhancement. with

 

  • Hard Preferred Equity, and
  • Soft Preferred Equity if modifications to the transfer provisions of the Loan DocumentsLoan DocumentsAll Fannie Mae-approved documents evidencing, securing, or guaranteeing the Mortgage Loan. are requested for the benefit of the Soft Preferred Equity holder.
1602.03

Hard Preferred Equity
1602.03A

Submission

Operating Procedures

You must submit the following in DUS GatewayDUS GatewayMultifamily pre-acquisition system, or any successor systems, recording deal registration, Pre-Review and/or waiver tracking, Mortgage Loan Commitments, and decision records. :

  • a sources and uses of funds reflecting the investment of the Hard Preferred Equity holder;
  • Exhibit B to the Multifamily Underwriting Certificate (Borrower) (Form 6460.Borrower);
  • a complete organizational chart of the BorrowerBorrowerPerson who is the obligor per the Note. , including upper tier entities or other owners, that shows the respective ownership percentages of PersonsPersonsLegal person, including an individual, estate, trust, corporation, partnership, limited liability company, financial institution, joint venture, association, or other organization or entity (whether governmental or private). holding any
    • direct or indirect control of the management and operations of the BorrowerBorrowerPerson who is the obligor per the Note. ,
    • ownership of a direct or indirect interest of 25% or more in the BorrowerBorrowerPerson who is the obligor per the Note. , and
    • ownership of any other direct or indirect interest in the BorrowerBorrowerPerson who is the obligor per the Note. that constitutes Hard Preferred Equity; and
  • copies of the organizational and other documents that govern the
    • Hard Preferred Equity, and
    • Hard Preferred Equity holder, including any
      • term sheets,
      • private placement memoranda,
      • operating agreements,
      • pledge agreements,
      • guaranties, or
      • similar arrangements.
1602.03B

Outside Counsel and Due Diligence Fees

Operating Procedures

The BorrowerBorrowerPerson who is the obligor per the Note. must pay the legal fees if Fannie Mae engages outside counsel.

These fees are non-refundable, and you must pay the counsel retainer when you submit the underwriting. 

Guidance

You may charge the BorrowerBorrowerPerson who is the obligor per the Note. your own legal and due diligence fees.