Pari Passu

A Latin term used to describe the equal treatment of investors, returns or securities. In real estate, the term is commonly used in waterfall distribution models to reference the pro-rata distribution of profits based on each investor’s initial equity contribution percentage. The term is likewise commonly used to describe the cash flow from and to two or more lenders holding an equal position in the capital stack of a real estate investment.

Putting “Pari Passu” in Context

Vanguard Property Partners (VPP) is a real estate private equity firm managing the Equilibrium Real Estate Income Fund, a diversified Core fund comprising stabilized assets including a Class A office building in Chicago, a grocery-anchored retail center in Dallas, and an industrial warehouse in Atlanta. As the Portfolio Manager for the fund, Alex Carter is responsible for calculating the quarterly distribution of profits to the fund’s investors.

Background

The fund raised $100 million in equity from three institutional investors:

• Investor A: Contributed $50 million (50%)
• Investor B: Contributed $30 million (30%)
• Investor C: Contributed $20 million (20%)

The fund also secured $150 million in senior debt across the three properties, resulting in a total portfolio value of $250 million. The properties generate a combined Net Operating Income (NOI) of $15 million annually, with $10 million available for distribution after covering debt service and fund operating expenses.

Application of Pari Passu

In the current distribution period, the total $10 million available cash flow will be distributed pari passu among the investors based on their proportional equity contributions. Since the fund’s distribution waterfall specifies that returns up to a preferred return of 8% are distributed pari passu, each investor will receive their share based on their initial equity percentage.

Calculation

1. Preferred Return: The fund targets an 8% annual preferred return on equity contributions. The total preferred return requirement for the $100 million equity pool is:

• Preferred Return = 100,000,000 × 0.08 = 8,000,000

2. Pari Passu Distribution of Preferred Return: The $8 million is distributed pro-rata:

• Investor A (50%): 8,000,000 × 0.50 = 4,000,000
• Investor B (30%): 8,000,000 × 0.30 = 2,400,000
• Investor C (20%): 8,000,000 × 0.20 = 1,600,000

3. Excess Distribution: After distributing the $8 million preferred return, $2 million remains:

• Investor A (50%): 2,000,000 × 0.50 = 1,000,000
• Investor B (30%): 2,000,000 × 0.30 = 600,000
• Investor C (20%): 2,000,000 × 0.20 = 400,000

4. Total Distribution:

• Investor A: 4,000,000 + 1,000,000 = 5,000,000
• Investor B: 2,400,000 + 600,000 = 3,000,000
• Investor C: 1,600,000 + 400,000 = 2,000,000

Insights

The pari passu method ensures that each investor is treated equally and proportionately based on their equity contributions. By distributing both the preferred return and excess cash on a pro-rata basis, VPP adheres to its fiduciary responsibility while maintaining alignment with the agreed distribution waterfall. Pari passu also simplifies calculations and prevents disputes, particularly when distributions are based on clear equity allocation percentages.