Pari Passu Explained
What does Pari Passu mean?
Pari Passu can be literally translated to mean side by side, or “on an equal footing”.
In commercial real estate, pari passu is a term used to describe two investors, creditors, or assets that are on equal footing. In other words, neither holds more or less weight than the other.
Pari passu is used most frequently to describe how CRE investors are to receive payouts. This is of particular importance when waterfall payout structures have been implemented. Pari passu is also used often in cases where two creditors or investors have equal claim on a borrower’s assets in the case of a default on the loan note.
Pari Passu vs. Pro Rata Share
Oftentimes in commercial real estate, pari passu gets confused with pro-rata. While the confusion is an easy one to make for less seasoned investors, the terms are uniquely different in both meaning and implication. A pro rata share is when each shareholder is given an equal proportion for every share of a given investment. Pari passu, is a term that boils down to all obligations being of the same class and priority. It gets a bit trickier when you take into consideration that in practice, debts that are designated as pari passu pay out a pro rata share to each investor or creditor, as they are all “on equal footing”.
Pari Passu in Regards to Waterfall/Promote Structures
When a commercial real estate investment involves a waterfall and promote structure, sometimes known as a waterfall model, it means that profits from the real estate investment get distributed in an uneven way. Typically this means that the sponsors of the project are given a disproportionate share of the profits (known as a promote), if the project hits certain predetermined profitability benchmarks. In most cases, all general partners on this sponsor level will be treated pari passu, meaning they will all get an equal amount of return pro rata.
Even so, in many cases, the sponsor/general partner (GP), members treated pari passu up to a certain return (often referred to as hurdles). Beyond such a hurdle, 9%/year, for example, the sponsor/GP is issued a promote, in addition to their pro rata share. This means that the sponsor is entitled to payout in an amount based on a set percentage of all profits above and beyond the 9% hurdle.There may also be subsequent hurdles to follow the first, each of which offers greater incentives to the sponsor. For example, a sponsor could be entitled to a promote of 15% of all profits past 9%, and a promote of 25% of all profits beyond 15%.
Pari Passu and CMBS Loans
Commercial mortgage backed securities (CMBS) use pari passu notes to mitigate the risk of any one CMBS loan across multiple different bond securitizations. In common practice, CMBS loans are divided into A-piece notes and B-piece notes. An A-piece note will be paid first, while B-piece notes are not only to be paid second, but may not be paid at all if a borrower defaults on their loan. B-piece notes are risky, but enjoy a higher interest rate due to the higher risk.
Typically speaking, only A-piece notes get broken into multiple pari passu notes. Among these multiple A-piece notes, each note will be paid back on equal footing to the others, ensuring that no one group of investors benefits more or less than the others. Consider, a $20 million CMBS loan could be portioned into three pari passu A- notes valued at $5MM, and one B-note. Each A-note would be placed into a different CMBS. In this example, the $5MM B-piece note would receive subordinate (non-pari passu) treatment.
Related Questions
What is pari passu in commercial real estate financing?
In commercial real estate, pari passu is a term used to describe two investors, creditors, or assets that are on equal footing. In other words, neither holds more or less weight than the other.
Pari passu is used most frequently to describe how CRE investors are to receive payouts. This is of particular importance when waterfall payout structures have been implemented. Pari passu is also used often in cases where two creditors or investors have equal claim on a borrower’s assets in the case of a default on the loan note.
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What are the benefits of pari passu financing?
The benefits of pari passu financing are that it ensures that all creditors or investors have an equal claim on a borrower’s assets, especially in the case of a borrower default. It also ensures that all investors in the same class receive the same amount of money, regardless of the amount of money they invested. This helps to protect investors from any potential losses due to a borrower defaulting on their loan note.
Pari passu financing also helps to ensure that all investors receive their payouts in a timely manner, as it eliminates any potential delays due to preferential treatment of one investor over another. This helps to ensure that all investors are treated fairly and that their investments are protected.
What are the risks associated with pari passu financing?
The main risk associated with pari passu financing is that if the borrower defaults, all creditors or investors have an equal claim on the borrower's assets. This means that if the borrower is unable to pay back the loan, all creditors or investors will receive the same amount of money, regardless of the amount of money they invested. This can be a problem if one creditor or investor has invested more money than the others, as they will not receive a proportionate return on their investment.
Another risk is that if the borrower is unable to pay back the loan, the creditors or investors may not receive their money back at all. This is especially true if the borrower has multiple creditors or investors, as they will all be competing for the same assets.
How does pari passu financing work?
Pari passu financing works by ensuring that all creditors or investors have an equal claim on a borrower’s assets, especially in the case of a borrower default. It is also used to ensure that all investors in the same class receive the same amount of money, regardless of the amount of money they invested.
For example, if two investors invest in a commercial real estate project, they would both receive the same amount of money from the project, regardless of the amount of money they invested. This is because pari passu financing ensures that all investors in the same class receive the same amount of money.
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What are the requirements for obtaining pari passu financing?
In order to obtain pari passu financing, you must meet certain requirements. These requirements vary depending on the type of financing you are seeking. Generally, you must have a good credit score, a solid business plan, and a strong track record of success in the industry. Additionally, you must be able to demonstrate that you have the financial resources to repay the loan. Finally, you must be able to provide collateral to secure the loan.
For more information on pari passu financing, please visit https://commercialrealestate.loans/commercial-real-estate-glossary/pari-passu and apartment.loans/posts/pari-passu-explained.