Commercial real estate financing is structured in layers (the capital stack), each with a defined risk and return profile. Senior debt sits at the top of the priority waterfall, first to be repaid with the lowest risk and lowest rate, and typically represents 60-75% of total capitalization on stabilized assets.
Below senior debt sit mezzanine debt and preferred equity, which absorb losses before the common equity and receive higher returns in exchange. Common equity sits at the bottom: last in priority, highest risk, highest return target.
Understanding where each dollar in the capital stack sits relative to the others determines every dollar's risk-adjusted yield, call rights, and loss exposure.
The senior debt market spans several product types matched to different asset life-cycle stages. Construction loans are short-term (typically 24-36 months), floating-rate facilities that fund in draws against verified completion milestones, sized at 60-70% of total project cost (loan-to-cost).
Bridge loans are short-term stabilization facilities for value-add acquisitions (properties not yet at stabilized occupancy), sized at 65-75% LTV on an as-stabilized basis. Permanent loans are long-term (5-10-year term, 20-30-year amortization), fixed or floating rate, typically 65-75% LTV on stabilized assets.
Agency loans (Fannie Mae and Freddie Mac in the United States, CMHC MLI Select in Canada) offer the best available terms for multifamily. CMBS (commercial mortgage-backed securities) offers non-recourse financing at scale but comes with prepayment lockouts such as yield maintenance or defeasance, and limited flexibility for asset management changes.
Lenders evaluate debt risk through three primary metrics. Debt service coverage ratio (DSCR), net operating income divided by annual debt service, must typically clear 1.20x-1.25x at underwriting.
Loan-to-value (LTV), loan amount divided by appraised value, is the primary constraint on smaller loans; most senior lenders cap at 65-75% LTV for income-producing assets. Debt yield (NOI divided by the loan amount) is the metric that has gained primacy in institutional lending because it is independent of interest rates and cap rates; lenders use it to gauge the actual return they would receive if they had to take back the property.
Debt yield floors of 7-9% are common in institutional CMBS and life company lending.
The equity side of the capital stack typically follows a limited partnership structure in institutional transactions. The general partner (GP) contributes 10-20% of the equity and controls asset management decisions; limited partners (LPs) contribute 80-90% of equity capital and take a passive role.
Distributions flow through a waterfall: LPs first receive a preferred return (commonly 7-9% IRR hurdle) on their invested capital; once the preferred return is satisfied, the GP receives a disproportionate share of further profits (the promote or carried interest, typically 20-30% of proceeds above the hurdle). Mezzanine debt and preferred equity fill the gap between senior debt proceeds and available common equity, accepting a defined yield (typically 10-14%) in exchange for structural priority over the LP equity and, in default scenarios, the right to foreclose on the GP's interest.
Senior debt comes in products matched to where an asset is in its life. Construction loans are short-term, floating-rate facilities (often 24 to 36 months) that fund in draws against verified completion and are sized to loan-to-cost. Bridge loans are short-term facilities for value-add or not-yet-stabilized assets, sized on an as-stabilized basis. Permanent loans are longer-term (commonly 5 to 10 year terms with 20 to 30 year amortization), fixed or floating, on stabilized assets.
Beyond those, agency loans (Fannie Mae and Freddie Mac in the US, and CMHC-insured programs such as MLI Select in Canada) offer the most favorable terms for multifamily, and CMBS provides non-recourse debt at scale but with rigid prepayment (yield maintenance or defeasance) and limited flexibility for asset-management changes. Junior capital (mezzanine debt and preferred equity) sits behind the senior loan and ahead of common equity, taking more risk for a higher return.
Lenders run three sizing tests and lend to whichever is most binding. Loan-to-value caps the loan as a percentage of appraised value, commonly 65 to 75% on income-producing assets. Debt service coverage ratio (NOI divided by annual debt service) must typically clear about 1.20x to 1.25x at underwriting, ensuring the property covers its payments with a cushion.
Debt yield (NOI divided by the loan amount) has become the metric institutional lenders trust most, because it does not move with interest rates or cap rates the way LTV and DSCR do; it states the unlevered return the lender would earn if it foreclosed and owned the asset. Floors of roughly 7 to 9% are common in CMBS and life-company lending. Our dedicated topic on DSCR and loan sizing works through these mechanics in more depth.
Above the debt sits equity, which in institutional deals is usually a limited partnership: a general partner contributes a minority of the equity and runs the asset, while limited partners provide most of the capital passively. Distributions flow through a waterfall, with limited partners typically receiving a preferred return before the general partner earns its promote.
The distinction between financing types is one of priority and price. Senior debt is repaid first and costs the least; each layer below it (mezzanine, preferred equity, then common equity) takes more risk and demands a higher return. Our dedicated topic on the capital stack covers how those layers are ordered and how loss flows through them.
The core products are construction loans (draws against completion), bridge loans (short-term financing for value-add or lease-up), permanent loans (long-term debt on stabilized assets), agency and insured loans (Fannie Mae, Freddie Mac, and CMHC programs) for multifamily, and CMBS, which pools loans into bonds for non-recourse financing at scale.
A bridge loan is short-term, higher-cost debt used to acquire or reposition an asset that is not yet stabilized, sized on the expected stabilized value. A permanent loan is long-term, lower-cost debt placed once the asset is stabilized, with a multi-year term and long amortization on the in-place income.
Lenders apply three tests and lend to whichever binds first: loan-to-value (loan as a share of appraised value, often 65 to 75%), debt service coverage ratio (NOI divided by debt service, commonly a 1.20x to 1.25x minimum), and debt yield (NOI divided by the loan, commonly a 7 to 9% floor).
Debt yield is NOI divided by the loan amount. Lenders favor it because, unlike LTV and DSCR, it does not move with cap rates or interest rates; it states the unlevered return the lender would earn if it took back and operated the property. Floors of about 7 to 9% are common in CMBS and life-company lending.
Agency loans are multifamily mortgages made under government-sponsored programs: Fannie Mae and Freddie Mac in the United States, and CMHC-insured programs such as MLI Select in Canada. They generally offer the most favorable terms available for qualifying rental housing, including higher leverage and longer amortization.
Debt is repaid first and costs the least, with senior loans at the top of the priority waterfall. Equity sits at the bottom, last to be repaid and highest risk, in exchange for the highest return and control of the asset. Mezzanine debt and preferred equity are intermediate layers between the two.
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