Multifamily investments often use a “dual tranche” equity structure to attract investors with different risk tolerances. In a dual tranche structure, investors are offered preferred units and common units. The preferred group receives a fixed annual rate of return much like a bond. The “preference” they receive is to be paid first whenever there is a distribution. If the preference is cumulative they will receive a “catch up” distribution to ensure they receive their fixed rate of return if a payment is skipped. The downside to preferred equity is that distributions are limited to the stated rate, and will not be paid in excess of this cap. So, in exchange for a more secure, stable payment, preferred investors are willing to give up potential gain beyond the stated yield.
Common equity investors are not subject to this cap and share in profits based on their ownership percentage. That said, common equity holders risk not receiving any distributions until there is cash to distribute and after the preferred equity investors are paid their fixed rate of return. If a distribution to common equity investors is skipped, it is ordinarily not made up again. The focus of common equity investors is generally the potentially “unlimited” payout of distributable cash, which outweighs security of a fixed, regular distribution of preferred equity.