The Capital Stack

The Capital Stack: Who Gets Paid and When

Every real estate deal is funded by layers of capital. These layers, stacked from most secure at the bottom to most risky at the top, form the capital stack. The stack determines who gets paid first if the deal performs, who takes losses first if it does not, and what return each investor can expect for the risk they absorb. Understanding the capital stack is the foundation of institutional real estate finance. If you cannot read a capital stack, you cannot evaluate a syndication, a fund, or any deal that involves other people's money.

The Layers, Bottom to Top

Think of the capital stack as a vertical bar. Money flows in from the top when the deal is funded. Money flows out from the bottom when the deal produces income or sells. The bottom layers get paid first and carry the least risk. The top layers get paid last and carry the most risk, but they also capture the most upside when things go well.

• Senior Debt (bottom): First position mortgage. Gets paid first. Lowest risk, lowest return. Typically 60-75% of the deal's value.
• Subordinate Debt: Second position or B-note. Gets paid after senior debt. Higher rate to compensate for the junior position.
• Mezzanine Debt: Loan secured by ownership interests (not the property). Sits between debt and equity. Often convertible.
• Preferred Equity: Equity position with a fixed preferential return. Gets paid before common equity but after all debt layers.
• Common Equity (top): Last in line for distributions. First to absorb losses. Unlimited upside potential.

Capital Stack: Risk vs. Return

Each layer in the stack represents a tradeoff between security and return. Senior debt holders accept 4-8% because they are first in line. Common equity targets 15-25%+ because they are last.

A $10M Apartment Acquisition

A 120-unit apartment complex is purchased for $10 million. The capital stack: $6.5M senior debt (65% LTV) at 5.5% interest from a regional bank. $1M mezzanine debt at 12% from a private lender. $500K preferred equity at 10% pref from a family office. $2M common equity from LP investors and the GP. The bank gets paid its $6.5M plus interest before anyone else. The mezz lender gets their $1M plus 12% next. The preferred equity holder gets their $500K plus the 10% preferred return. Whatever remains goes to common equity. If the property sells for $12M, common equity makes a strong return. If it sells for $7M, common equity is wiped out, preferred equity takes a haircut, and the mezz lender may lose principal. The bank still gets repaid in full.

Senior Debt: The Foundation

Senior debt is the first mortgage on the property. It sits at the bottom of the stack because it has the first claim on assets. If the borrower defaults, the senior lender forecloses and takes the property. Everyone above them in the stack loses before the senior lender takes any loss. Because of this security, senior debt commands the lowest returns in the stack, typically 4-8% interest. Banks, insurance companies, CMBS conduits, and government agencies (Fannie, Freddie, HUD) are the primary senior lenders in commercial real estate.

Capital Stack Layer Comparison

Each position in the stack carries a distinct risk, return, and priority profile.

The capital stack defines every investor's risk, return, and priority in a deal. Lower in the stack means more security and less upside. Higher means more risk and more reward. Before investing in any real estate deal, identify where your capital sits in the stack. That single piece of information tells you more about your risk than almost anything else in the offering documents.