Investors often ask, “What is a real estate capital stack?”

The capital stack is a legal representation of the financial structure of a commercial real estate deal. It visualizes the various types of capital used to finance a real estate project. It shows the order in which investors and lenders are paid back and the risk and reward associated with each type of capital. A real estate capital stack comprises senior debt (typically a first mortgage), common equity, and sometimes preferred equity or mezzanine debt.

SENIOR DEBT

Senior debt typically refers to a first mortgage (primary loan used to buy a property); it takes precedence over the entire capital stack. When a first mortgage is obtained, the lender places a lien on the property, giving them the first claim to that property upon a sale or even a foreclosure. In other words, if the property sells, the first mortgage is paid before any distributions.

MEZZANINE DEBT

Mezzanine Debt is a debt and equity hybrid typically used to reduce a borrower’s equity requirement. It takes precedence over preferred and common equity. Mezzanine debt is sometimes utilized to bridge the gap between the first mortgage and the common equity. It is senior to common equity but subordinate to the first mortgage.

PREFERRED EQUITY

Preferred equity is an investment that gives investors a fixed rate of return (usually a dividend) and a priority claim on profits before common equity holders are paid. It is less risky than common equity because the preferred return rate is fixed and stipulated in the operating agreement. However, sponsors might find that it benefits the deal to have preferred equity investors on a short-term basis, meaning they could be replaced with cheaper debt. [1]

COMMON EQUITY

Common equity is a portion of the capital that limited and general partners invest in an asset. Unlike the first mortgage, if the property sells, the common equity is the last to get paid off and is subordinate to the entire capital stack. However, common equity investors can share in the deal’s upside at the time of sale. [1]

To summarize, if a property sells, the first mortgage is paid off first, preferred equity or mezzanine debt is paid off next, depending on the deal, and the common equity is last to get paid off. As a result, these investments have different return and yield metrics based on their respective positions in the real estate capital stack.

CONNECT WITH AN INSTITUTIONAL REAL ESTATE OWNER/OPERATOR

BAM Capital partners with accredited investors who want to enjoy passive income and all the other benefits of multifamily private placement. As the private equity arm of The BAM Companies, BAM Capital has been focusing on buying the most profitable assets and staying disciplined in its investment thesis. BAM Capital’s investment strategy aims to create forced appreciation while mitigating investor risk. To date, the brand has successfully managed over $1.7 billion in assets across ~9,000 apartment units. [2]

Remember that no investment is without risk. Before making financial decisions, consult your investment advisor and schedule a call with a BAM Capital investment team member.

Disclaimer: All investments carry risk, including potential loss of capital. This content is for informational purposes only and is not financial, legal, or investment advice, nor an offer or solicitation to buy or sell any security. Consult an independent advisor for personalized guidance and contact BAM Capital for details on current offerings. BAM Capital and its representatives are not fiduciaries or investment advisors. The information provided is general and may not reflect individual financial goals. Any financial terms, projections, or forward-looking statements contained herein are hypothetical in nature and should not be interpreted as guarantees of future performance or safety. Such statements reflect BAM Capital’s opinion and are subject to market fluctuations, economic conditions, and investment risks. Past performance does not predict future results. BAM Capital and its affiliates do not guarantee the accuracy or completeness of this information. BAM Capital offers investment opportunities under Rule 506(c) of Regulation D exclusively for accredited investors as defined by the SEC. Verification of accredited investor status is required prior to participating in any investment.

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SOURCES:

[1]: Tactica Real Estate Solutions. (n.d.). “Exploring Preferred Equity in the Real Estate Capital Stack.” https://www.tacticares.com/blog-feed/exploring-preferred-equity-in-the-real-estate-capital-stack#:~:text=Preferred%20Equity%20vs.,-Common%20Equity&text=As%20an%20investor%2C%20the%20benefits,%2C%20quarterly%2C%20or%20accrue). 

[2]: BAM Capital. (n.d.). “Current portfolio.” https://bamcapital.com/