The capital stack is the ordered list of every layer of debt and equity that finances a commercial real estate deal, ranked by priority of payment and security. Senior debt sits at the bottom — first priority, lowest risk, lowest return. Common equity sits at the top — last priority, highest risk, highest return. Each layer in between trades risk for return at a different point on the curve.
A typical institutional capital stack might include senior mortgage debt at 60% loan-to-value, mezzanine debt or preferred equity filling another 15% to 20%, and common equity covering the remaining 20% to 25%. The senior lender has a first lien on the property and gets paid first; the mezzanine lender gets paid next, secured by a pledge of equity interests rather than by the real estate itself; preferred equity ranks behind debt but ahead of common; and common equity collects whatever remains.
The capital stack matters because it determines who absorbs losses first when things go wrong. A 10% drop in property value wipes out the bottom 10% of the capital stack first — usually some or all of the common equity. A 30% drop starts cutting into preferred equity. A 50% drop reaches the mezzanine layer. Senior debt is only impaired in catastrophic scenarios. Understanding this ordering is the foundation of CRE risk analysis.
Capital stack design also drives returns. More debt (higher leverage) increases potential equity returns when the deal works but accelerates losses when it doesn't. Adding mezzanine debt or preferred equity lets the sponsor reduce common equity needs and increase the equity multiple, but adds another paid claim ahead of the common position. These tradeoffs are at the heart of every institutional CRE financing decision.
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