The Commercial Real Estate Capital Stack

Published on May 1, 2021

The commercial real estate capital stack is an organizational model that outlines a commercial real estate project’s hierarchy of capital contributions. The stack is split between debt and equity investments with the lowest risk and lowest return investments at the bottom of the stack and the high-risk high return equity investments at the top. The capital stack is a useful analytical tool for commercial investors.

Debt Investing

The foundation of the capital stack represents a deal’s debt contributions. These lenders have priority and will receive payments first when the property generates sufficient cash flows. The debt section is split between senior debt and hybrid mezzanine debt.

Senior Debt

Senior debt typically funds around 75% of a project’s total cost and can be a more secured position in the capital stack. Senior debt lenders will receive their payouts first before any other investor and are usually mortgage lenders. Mortgage lenders have the benefit of retaining the real property asset as collateral on their investment.

Mezzanine Debt

Mezzanine debt is a hybrid debt that is second to senior debt in priority but offers lenders certain other benefits. A relationship between the senior debt lender and the mezzanine lender is outlined in a written instrument where the parties will establish the mezzanine loan’s subordination to the senior lender’s mortgage and define the respective rights and obligations of the parties.

The most important distinction between senior debt and mezzanine debt is the securitization of the respective loans. The senior lender will typically be secured by the real property asset through a mortgage while the mezzanine debt will be secured by a lien on the membership interest in the entity that owns the real property asset.

Risk Analysis

Debt investing offers the lowest associated risks in the capital stack. In the event of a default, senior and mezzanine debt investors can have a considerable chance of recovering their initial investments through liens on the collateral.

Equity Investing

Equity investments are at the top of the capital stack and are accompanied by both great risk and potentially lucrative rewards. An equity investor typically purchases a percentage of equity in the corporate entity holding the project’s real property assets. Equity investing is split into two categories in the capital stack, preferred equity, and common equity.

Common and Preferred Equity

Common equity sits at the top of the capital stack and typically represents the contributions made by the project’s interested parties. Equity investors will receive periodic payments in the form of dividends if the property is generating adequate cash flow. The term preferred equity refers to those investors who assume less risk by having payment priority over common equity holders. Although preferred equity can also be accompanied by other various agreed-to benefits such as enhanced voting rights and corporate management controls.

Risk Analysis

Unlike debt investors, equity investors have no means of securing their investments and have no guarantee of a return on their principal contribution. Despite the lack of security, equity investors could realize returns on a lucrative project.

Disclaimer

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security which can only be made through official documents such as a private placement memorandum or a prospectus. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Neither Concreit nor any of its affiliates provides tax advice or investment recommendations and do not represent in any manner that the outcomes described herein or on the Site will result in any particular investment or tax consequence.Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Concreit does not guarantee its accuracy.

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