What it is
The capital stack is the full set of money that pays for a property, arranged by priority. The layers at the bottom of the diagram get paid first and take the least risk. The layers at the top get paid last and take the most risk, so they expect the highest return.
The layers
| Layer | Priority | Risk and return |
|---|---|---|
| Senior debt | Paid first | Lowest risk, lowest cost |
| Mezzanine debt | After senior | Higher risk, higher cost |
| Preferred equity | After all debt | Higher still |
| Common equity | Paid last | Highest risk, keeps the upside |
Not every deal has every layer. A simple acquisition might be senior debt plus the sponsor's common equity.
Example
A $20,000,000 acquisition:
| Layer | Amount | % of cost | Cumulative |
|---|---|---|---|
| Senior loan | $12,000,000 | 60% | 60% |
| Mezzanine loan | $2,000,000 | 10% | 70% |
| Preferred equity | $2,000,000 | 10% | 80% |
| Common equity | $4,000,000 | 20% | 100% |
The figures are illustrative. If the property later sells for $17,000,000, the senior and mezz lenders are repaid in full, the pref investor gets $2,000,000, and common equity gets $1,000,000 of its $4,000,000 back. The bottom of the stack was protected by every layer above it.
Sources and uses
The capital stack is usually presented as a sources and uses table. Sources lists every layer of capital. Uses lists purchase price or land, hard and soft costs, closing costs, reserves and fees. The two totals must match.
Why lenders care
A senior lender looks at the whole stack, not just its own loan.
- Leverage. Combined LTV or LTC through each layer shows how much cushion sits beneath each lender.
- Coverage. Combined debt service shows how stretched the property is.
- Control. Mezzanine and preferred equity holders may have rights to take over the deal. Senior lenders want to know who could end up in control.
- Sponsor commitment. How much of the common equity is the sponsor's own money, rather than raised from investors.
Common mistakes
- Hiding layers. Lenders will find subordinate financing in diligence. Disclose it up front.
- Sources and uses that don't balance. It's the first table many lenders check.
- Ignoring intercreditor terms. Senior lenders often limit what can sit behind them.
In the package
Put the sources and uses and the stack near the front of the loan package, with each layer's terms. See how to package a commercial real estate loan.