Understanding the Capital Stack in Commercial Real Estate
In commercial real estate investing, the capital stack is a crucial concept that explains how different sources of capital combine to finance a property acquisition, development, or renovation. Randy Efron from Skylatus Property Capital shares valuable insights into this structure that helps investors and sponsors understand risk, returns, and prioritization in deals.
What Is the Capital Stack?
The capital stack is a layered framework representing the hierarchy of financial claims on a commercial property. It shows how the capital used to fund a project is organized, distributed, and repaid based on each portion’s risk profile and priority. Capital typically breaks down into two main categories:
Debt: Includes senior mortgages, mezzanine loans, and other subordinated debt.
Equity: Comprises preferred equity and common equity invested by sponsors or outside investors.
The layers in the stack define who gets paid first in case of income distribution or default and who assumes the highest risk but potential reward.
How the Capital Stack Works
Imagine the capital stack as a vertical building with layers:
The bottom layer is senior debt — it carries the lowest risk and the highest payment priority, often secured by a first lien on the property.
Above that is mezzanine debt or subordinated debt, which carries moderate risk and payment priority.
Equity sits at the top layers of the stack — it assumes the greatest risk but also aims for superior returns.
If property income or sale proceeds are limited:
Senior debt holders get fully repaid first.
Mezzanine lenders are paid next, if possible.
Equity investors receive remaining cash flow or profits last, absorbing losses first if the property underperforms.
Why Capital Stack Matters to Investors and Sponsors
Risk Assessment: Understanding the stack helps investors gauge their position’s risk and expected returns.
Financing Strategy: Sponsors use the stack to optimize capital costs, balance leverage, and align investment goals.
Deal Structuring: The layers clarify repayment order, investor protections, and financing flexibility, especially for complex deals involving multiple lenders or investors.
Practical Example
A $100 million commercial property might have:
60% senior mortgage (lowest cost, first lien).
15% mezzanine debt (higher cost, second lien).
25% equity (highest risk and return).
This arrangement allows sponsors to raise sufficient capital while managing risks and costs effectively.
To learn more about capital structure strategies in commercial real estate, contact Randy Efron at randy.efron@skylatus.com or visit Skylatus Property Capital.