The Capital Stack — Who Gets Paid, When, and at What Return

Every commercial real estate deal is funded by a mix of debt and equity. On a simple deal, it's just a bank loan plus your down payment. On a large or complex deal, you might have four or five different layers of capital, each with different terms, different returns, and a different position in line to get paid.

The "capital stack" is the industry's term for this layered structure. Understanding it is critical because:

1. It determines where the risk and reward of a deal get distributed
2. It determines how much leverage the deal can support
3. It unlocks larger deals that wouldn't be possible with just bank debt and your own equity

The four standard layers

Here's the stack, from safest to riskiest:

┌─────────────────────────────┐
│      Common Equity          │  ← Highest risk, highest return
├─────────────────────────────┤
│      Preferred Equity       │
├─────────────────────────────┤
│      Mezzanine Debt         │
├─────────────────────────────┤
│      Senior Debt            │  ← Lowest risk, lowest return
└─────────────────────────────┘

The rule: money gets paid from the bottom up. Senior debt gets paid first out of cash flow and in any sale or foreclosure. If there's anything left, mezz gets paid. Then preferred equity. Then common equity — but common equity only gets paid if everything above it has been satisfied.

This "waterfall" structure is why the common equity is both the riskiest position AND the one with the highest potential return. You're taking the first loss if things go wrong, so you get the first big wins when things go right.

Layer 1: Senior debt

What it is: The primary mortgage secured by the property. Usually 55%-75% of the total capital stack.

Who provides it:

• Commercial banks (most common for small-to-mid deals)
• Life insurance companies (long-term fixed rate on stabilized assets)
• CMBS lenders (securitized loans)
• Agency lenders, Fannie Mae and Freddie Mac (multifamily only)
• SBA (owner-user commercial, up to 90% LTV on SBA 504)
• Bridge lenders (short-term, higher rate, value-add)

Typical terms (2026):

• Rate: 6-8% on conventional bank debt, 7-9% on bridge
• Amortization: 20-30 years
• Term: 5-10 years with balloon
• LTV: 55-75%
• DSCR required: 1.20-1.40x

Expected return to lender: equal to interest rate (6-8%), plus fees. Very low risk.

Position: First lien on the property. Gets paid every month before anyone else, and if the deal fails, gets the first dollar of any sale or foreclosure proceeds.

What senior debt looks like on a $5M deal

• Purchase price: $5,000,000
• Senior debt at 70% LTV: $3,500,000
• Interest rate: 7.0%
• Amortization: 25 years
• Annual debt service: approximately $296,000

Senior debt is the foundation of almost every commercial real estate deal. On small deals, it's often the only debt — everything above the senior loan is equity.

Layer 2: Mezzanine debt

What it is: Additional debt layered on top of the senior loan to increase total leverage. Typically fills the gap between the senior lender's maximum and the equity sponsor's desired contribution.

Who provides it:

• Specialty mezz funds
• Private credit firms
• High-net-worth individuals
• Some life insurance companies

Typical terms:

• Rate: 10-14% (significantly higher than senior)
• Term: usually matched to senior debt
• Security: typically a pledge of the equity (not a direct lien on the property) — if mezz isn't paid, they can foreclose on the equity interest, effectively taking over the deal
• Minimum deal size: usually $10M+ (doesn't work on small deals)

Expected return to lender: 10-14% plus fees. Moderate risk.

Position: Second in line. Gets paid after senior debt but before equity.

Why sponsors use mezz

Senior lenders cap LTV at 70-75%. If a sponsor wants higher leverage (say 85%), they can add mezz to fill the 75-85% range. Mezz is expensive (10-14% vs. senior's 6-8%), but it frees up equity that the sponsor can use to pursue more deals.

Example. A $20M property:

• Senior debt at 70% LTV: $14,000,000
• Mezz debt at 15% of the stack: $3,000,000
• Common equity: $3,000,000

Without mezz, the sponsor would need $6M of equity. With mezz, they need $3M — letting them do twice as many deals with the same equity base.

The catch: mezz eats into cash flow significantly, and in a downturn it can be the first thing to get wiped out when the deal underperforms.

Layer 3: Preferred equity

What it is: Equity that has a preferred return and priority over common equity, but sits below all debt in the capital stack.

Who provides it:

• Family offices
• Private equity funds
• Passive investors in syndications
• Some institutional investors

Typical terms:

• Preferred return: 8-12% per year on invested capital
• Not interest-bearing — it's equity, so if cash flow is insufficient, the preferred return accrues rather than forcing default
• Sometimes has a "catch-up" feature where preferred equity gets its full return plus participation in upside
• Sometimes has a hard maturity date where it must be redeemed

Expected return: 8-14% blended (preferred return plus any upside participation).

Position: After debt (both senior and mezz) but before common equity.

Why preferred equity exists

It's a compromise between debt and equity. Debt lenders want predictable payments and won't take equity-like risk. Equity investors want upside but don't want to share it all with the sponsor. Preferred equity splits the difference: steady-ish returns (but not guaranteed) with downside protection (but not debt-like seniority).

Layer 4: Common equity

What it is: The sponsor's own money plus any limited partner (LP) investor capital that doesn't have preferred status.

Who provides it:

• The sponsor/general partner (GP)
• Limited partner (LP) investors in a syndication
• Individual deal equity from solo investors

Typical terms:

• No fixed return — gets whatever's left after everyone senior to them is paid
• Sponsor usually takes a "promote" or "carried interest" on LP capital, earning a bigger share of profits above a preferred return hurdle
• Full upside participation

Expected return: 15-25%+ IRR on successful deals. Negative on failed deals.

Position: Last in line. First to take losses, last to be paid.

Why common equity is where wealth gets made

The math of leverage means that small percentage gains on a big property translate into huge percentage gains on common equity. If a $10M property appreciates 20% to $12M, the $2M gain flows entirely to the common equity after senior debt is paid — on $2.5M of common equity, that's 80% return from appreciation alone.

Conversely, if that same property drops 20% to $8M, the $2M loss wipes out 80% of the common equity. Common equity is where the action is on both sides.

A realistic capital stack on a $15M deal

Let's build a complete stack for a mid-sized value-add multifamily deal:

Layer              Amount     % of total   Expected return
Senior debt      $10,000,000      67%           7.0%
Mezz debt         $1,500,000      10%          12.0%
Preferred equity  $2,000,000      13%          10.0% pref + upside
Common equity     $1,500,000      10%          18-22% IRR target
Total            $15,000,000     100%

Note what's happening: the sponsor has put up only $1.5M of common equity but controls a $15M deal. That's 10-to-1 effective leverage on the sponsor's own cash. If the deal works, the sponsor earns big IRR on that small common equity slice. If it fails, the sponsor loses their $1.5M first, then preferred equity loses, then mezz, then senior — in that order.

The waterfall in action: how cash gets distributed

When the deal produces cash (or sells), the waterfall pays in order:

1. Senior debt service (interest + principal) — paid every month
2. Mezz debt service — paid every month (or accrued)
3. Preferred equity preferred return — paid if available, or accrued
4. Return of capital to preferred and common equity — at sale or refinance
5. Remaining profits split per the LP agreement — often 70% LP / 30% GP after the preferred return hurdle is met

The last bullet is where the "promote" lives. Sponsors typically earn 20-30% of profits above a preferred return, even though they contributed less capital. This is how syndication sponsors make their money — on the promote, not on their own equity.

When to use what

Small deals ($1-5M): Senior debt + your equity. Maybe an SBA 504 if it's owner-user. Don't overcomplicate.

Mid deals ($5-20M): Senior debt + common equity (yours + a few LPs). Maybe preferred equity if you want to limit your personal cash contribution.

Large deals ($20M+): Full stack. Senior + mezz + preferred + common. Enables institutional-scale deals.

Development: Almost always requires a full stack. Senior construction loan, mezz for the gap, equity (GP and LP) for the ground-up risk capital.

The key insight for private investors

If you're a private investor buying your own deals, you'll use senior debt + your own equity for most of your career. You don't need mezz or preferred equity until your deal size gets large enough that you can't fund the equity portion yourself.

But understanding the full stack matters because:

1. When you invest as an LP in someone else's syndication, you'll see these structures in the PPM. You need to know what layer you're in.
2. When you eventually syndicate your own deals, you'll build these stacks for other people's capital.
3. When a lender offers you "stretch senior" or "A/B note structure" or "mezz", you need to understand what they're actually selling.

What to take away

• Every CRE deal has a capital stack of 1-4 layers: senior debt, mezz, preferred equity, common equity
• Payment flows from the bottom up — senior gets paid first, common equity last
• Returns are inverse to seniority: senior debt is ~7%, common equity targets 15-25%+
• Mezz and preferred equity let sponsors amplify leverage on bigger deals
• Small private investors mostly use just senior debt + their own common equity
• Understand the stack so you know what layer you're in on any deal — your own or a syndication

Next lesson: the final walkthrough — we take everything from this course and apply it to a complete deal from start to finish, comparing two alternative investments with different capital stacks.