The world of commercial real estate (CRE) is filled with complex financial arrangements, and understanding the terms involved is essential to maximizing returns and reducing risk. One of these terms,”‘ pari passu,” plays a significant role in the organization and distribution of funds within a commercial real estate transaction. Every investor who’s involved in a multi-party real estate arrangement should understand what’s meant by pari passu in commercial real estate.
What Does Pari Passu Mean?
Pari passu is a Latin term meaning “on equal footing” or “with equal step.” The term means that two or more parties will be treated equally, whatever the context for treatment. It’s used to indicate equal treatment of parties in commercial real estate arrangements (and separately in legal contexts as well).
Pari Passu Definition: To treat all members of a class equally.
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Understanding Pari Passu
Pari passu provisions are designed to protect the interests of multiple stakeholders in a financial transaction. The term doesn’t refer to how distributions are made, but rather a class of equal parties.
One scenario that shows pari passu’s import well is bankruptcy. In a bankruptcy filing, all creditors might be treated “pari passu,” as equal members of the same class. This means that all creditors would receive the same fractional amount when payments are made — no creditor is put ahead of another.
Importantly, pari passu doesn’t ensure that all parties will receive the same amount. Instead, fair treatment dictates that parties receive their proportionate share. The largest creditors should receive the largest payments in a bankruptcy proceeding, or else another creditor’s claim would be treated as greater.
In short, no party is given preferential treatment over another party that’s involved. A more detailed explanation of the bankruptcy example would state that all creditors have equal rights and responsibilities. Their rights are the right to repayment according to what their due.
How Does Pari Passu Apply in Commercial Real Estate
In commercial real estate, it’s not creditors that are treated “pari passu” but rather investors. All investors have the same rights and responsibilities. The rights entitle them to equal returns when distributions are made.
Again, this doesn’t mean that all investors receive the same amount when distributions are made. Instead, they’re paid according to their investment in the property. Whatever percentage they’ve invested is the percent that they’ll receive — everyone in the class of investors is being treated equally according to their respective contributions.
Pari passu arrangements are common in CRE partnerships, joint ventures and REITs.
Pari Passu Example
Consider an example involving two investors who jointly purchase a commercial property. Investor A contributes 60% of the capital, while Investor B contributes the remaining 40%.
Any proceeds from the property (from rent, appreciation or other source) are divided pari passu: 60% to Investor A and 40% to Investor B. The same can be extrapolated if there are more investors who’ve invested equal or varying amounts.
Benefits and Risks of Pari Passu in CRE
There are several benefits to incorporating pari passu provisions in commercial real estate agreements:
- Fairness: Pari passu ensures that all investors are treated fairly and receive their proportionate share of returns and liabilities.
- Expediency: Pari passu ensures that all investors receive their amounts due in a timely fashion, as no investor has to wait for another to be paid first.
- Transparency: Equal provisions create clear expectations among all parties, reducing the likelihood of disputes and misunderstandings.
- Collaboration: By establishing equal footing among investors, pari passu fosters an environment of cooperation and collaboration.
However, there are also potential risks to consider:
- Dilution of control: Pari passu can result in a dilution of control for individual investors, particularly in cases where multiple parties are involved.
- Complexity: Implementing and managing pari passu provisions can be complex and may require additional legal and administrative resources.
Pari Passu vs. Pro Rata: What’s the Difference?
While pari passu and pro rata are sometimes used interchangeably, they are not synonymous.
Pari passu refers to a class that’s to be treated equally. For example, all investors within a class are being treated fairly. This is usually fairly according to their investments.
Pro rata refers to how distributions are made. Investors receive distributions according to how much they’ve invested — someone who’s invested 60% of the total investment will get 60% of the returns.
The two terms are used interchangeably because there’s often little difference between the practical implications of each. To treat a class of investors fairly requires paying them returns according to their contributions. A pari passu agreement will frequently result in a pro rata distribution.
What’s the Impact of Pari Passu in CRE?
Pari passu plays a crucial role in promoting fairness and transparency in the commercial real estate industry. By ensuring equal treatment for all parties, these provisions help to build trust among investors and foster collaboration in joint ventures and other multi-party transactions.
Additionally, pari passu provision can help attract a diverse range of investors to a project, as they are assured of equal treatment and a clear understanding of their rights and responsibilities.
Wrapping Things Up
Pari passu is a fundamental concept in the world of commercial real estate, ensuring that all parties involved in a transaction are treated fairly and proportionately. By incorporating pari passu provisions in partnership agreements, joint ventures, and real estate investment trusts, investors can benefit from increased transparency, collaboration, and trust.
Confirm that any commercial real estate investment you enter into treats all investors like you pari passu. If someone is treated differently, there should be a clear reason why.