Definition
The capital stack represents the full picture of how a commercial real estate deal is financed. Every dollar in the deal comes from somewhere, and the capital stack maps each source according to its priority of repayment and risk profile. The typical capital stack has four layers, from bottom to top: senior debt (first mortgage), mezzanine debt, preferred equity, and common equity. Senior debt sits at the base and has the first claim on cash flow and sale proceeds, making it the lowest-risk position. Above that, mezzanine debt and preferred equity fill the gap between senior debt and common equity. Common equity sits at the top — it bears the most risk but captures the greatest upside when a deal performs well. The structure of the capital stack directly affects returns, risk, and control for every participant. A highly leveraged capital stack (more debt) amplifies both gains and losses, while a conservative stack (more equity) reduces risk but limits return potential. Understanding the capital stack is fundamental to evaluating any commercial real estate investment.
How It Works
When a sponsor structures a deal, they work from the bottom up. First, they secure senior debt — typically 55-75% of the property value. If there is a gap between what the senior lender provides and the equity the sponsor has available, they fill it with mezzanine debt or preferred equity. The remaining portion is common equity contributed by the sponsor and their investors. Each layer has distinct rights: senior debt is repaid first and has a mortgage lien; mezzanine debt is next with a pledge of ownership interests; preferred equity receives distributions before common equity; and common equity receives whatever remains after all other obligations are satisfied.
Example
A sponsor acquires a $10,000,000 retail property. The capital stack: Senior Debt — $6,500,000 (65%) at 6% interest. Mezzanine Debt — $1,500,000 (15%) at 12% interest. Preferred Equity — $1,000,000 (10%) at 10% preferred return. Common Equity — $1,000,000 (10%) from the sponsor and investors. If the property generates $750,000 in NOI, the waterfall is: $390,000 to senior debt service, $180,000 to mezzanine interest, $100,000 to preferred equity return, and $80,000 to common equity — an 8% cash-on-cash return on the sponsor's equity.
Why It Matters
The capital stack determines risk and return for every participant in a deal. Sponsors who understand how to structure a capital stack can optimize their cost of capital, maximize returns on equity, and attract the right mix of debt and equity partners. Investors evaluating deals must understand where they sit in the capital stack — because position determines both the safety of their investment and the upside they can expect.
H Equities
H Equities operates on both sides of the capital stack — providing bridge debt and mezzanine financing while also investing direct equity — giving sponsors a single counterparty who understands the full structure. Learn more
Frequently Asked Questions
What is the safest position in the capital stack?
Senior debt is the safest position because it has the first claim on property cash flow and sale proceeds, and it is secured by a mortgage lien on the property. In a downturn, senior debt is the last to take losses.
Why would a sponsor add more layers to the capital stack?
Adding layers like mezzanine debt or preferred equity allows the sponsor to reduce the common equity required, which can significantly boost returns on invested capital. However, more leverage also increases risk.
How does the capital stack affect returns?
Higher leverage (more debt) amplifies returns when a deal performs well but also magnifies losses when it underperforms. Each layer of the stack has a fixed cost, so more layers increase the total cost of capital but reduce the equity needed.
Related Terms
Senior Debt in Commercial Real Estate
The first mortgage or primary loan on a property, holding the highest priority claim on cash flow and sale proceeds in the capital stack.
Mezzanine Debt in Commercial Real Estate
A subordinate loan that sits between senior debt and equity in the capital stack, typically carrying higher interest rates in exchange for filling the financing gap.
Preferred Equity in Real Estate
An equity investment that receives a priority return before common equity holders, sitting between mezzanine debt and common equity in the capital stack.
Subordinate Debt
Any debt that ranks below senior debt in repayment priority, including mezzanine loans and B-notes, carrying higher interest rates to compensate for greater risk.
Co-GP Equity in Real Estate
Capital provided by a co-general partner alongside the lead sponsor, sharing in GP-level economics, responsibilities, and decision-making authority.