Understanding The Capital Stack

Well, I decided to take the plunge toward writing a newsletter on LinkedIn.

This is the first of many. I thoroughly enjoy writing and educating my network. With that said, I wanted to explain what the capital stack is. I think it gives a great foundation to real estate, especially real estate syndication. Regardless of whether you are an active or passive investor.

The capital stack is a term used in real estate and finance to describe the hierarchy of funding in a project. It typically consists of a few layers, each representing different levels of risk and return. The main layers of the capital stack include:

• Common Equity: This is the riskiest part of the capital stack. Common equity investors are the last to be paid out in case of a liquidation or sale, but they typically have the highest potential for returns. They own a share of the property and participate in the upside and downside of the investment. In a real estate syndication, people who participate in common equity are members of the ???? (?????????????? ??????????????????????). They are the individuals executing the business plan and are ???????????????? ????????????????.
• Preferred Equity: Preferred equity investors have a higher claim on the property’s cash flows and liquidation proceeds than common equity holders. They typically receive a fixed return before common equity investors receive any distributions. However, their upside potential is usually limited compared to common equity. In a real estate syndication, investors participating in preferred equity (also called pref equity) are considered to be ?????? (?????????????? ????????????????). They are ?????????????????? ???????????????? and do not have to lift a finger. They invest their capital once the property is under contract. Additionally, both common and preferred equity positions have access to tax benefits associated with real estate.
• Mezzanine Debt: This is a hybrid form of financing that sits between senior debt and equity. Mezzanine debt holders have a higher claim than equity holders but are subordinate to senior debt holders. It often comes with higher interest rates due to its higher risk. Mezzanine financing can also include equity kickers or warrants, giving lenders some participation in the equity upside. Personally speaking, I haven't seen too many deals that involve a mezzanine debt component. If I am helping raise equity on a property, I'm not a big fan of deals that have a mezzanine (mezz) component. ???????? ???? ?????????????? ???? ?????????????? ?????? ?????????????? ???????? ???????? ???? ???? ???????? ???????? ???????????? ?????????????????? ???????????? ??????????????????.
• Senior Debt: Senior debt is the most secure and has the highest priority in the capital stack. Lenders of senior debt are paid first from the property’s cash flows and have the first claim on the property in case of default. As a result, senior debt typically has the lowest interest rates. ???????????? ???????? ???? ?????????????????? ?????????????? ?????????????? ?? ?????????? ???????? ???? ?? ???????????????? ????????????.

Below is an image that gives a great visual of the capital stack:

I hope you found this helpful! Should you have any questions about real estate, please reach out.

Keep the cash flowing,

Brandon Gidicsin