Pari Passu Explained
In commercial real estate, pari passu simply means that two investors, creditors, or assets are on equal footing— that is, without preference to one or the other. Pari passu is most commonly used to describe the way that CRE investors receive payouts, especially when waterfall structures are being used. It’s also sometimes used to indicate that two creditors or investors have an equal claim on a borrower’s assets, especially in the case of a borrower default.
Pari Passu vs. Pro Rata Share
In commercial real estate, pari passu and pro-rata share are two terms that are often confused with each other. A pro rata share simply means that each shareholder gets an equal proportion for every share of an investment that they own. In contrast, pari passu means that all obligations are of the same class and priority. In practice, debts or obligations that are held pari passu will also distribute a pro rata share to each investor or creditor, since 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, in most cases, all general partners will be treated pari passu, meaning that they will all get an equal amount of return, at the same time, in a pro rata fashion. However, the sponsor/general partner (GP), will generally be only treated pari passu up to a certain return (or hurdle), say, 9%/year. Past that, they will receive a promote (an additional percentage of the profits), not just their pro rata share. For instance, a sponsor might be entitled to a promote of 15% of all profits above and beyond 9%. There may also be multiple hurdles, each of which offers greater incentives to the sponsor. For example, the sponsor might be entitled to a promote of 20% of all profits past 12%, and a promote of 30% of all profits beyond 15%.
Pari Passu and CMBS Loans
Commercial mortgage backed securities (CMBS) also use pari passu notes to break up the risk of any one CMBS loan to multiple different bond securitizations. CMBS loans are typically divided into A and B-piece notes; A-piece notes will be paid first, while B-piece notes are paid second (and may not be paid at all if a borrower defaults on their loan) but enjoy a higher interest rate, due to the higher risk. In general, only A-piece notes are broken into multiple pari passu notes, but, among these A-piece notes, each note will be paid back on equal footing to the others, so no group of investors benefits more or less. For example, a $20 million CMBS loan could be portioned into 3, $5 million pari passu A- notes, each which is placed into a different CMBS. In this example, the other $5 million note would be a B-piece note, which would receive subordinate (non-pari passu) treatment.