The capital stack is the layered structure of all financing behind an investment — typically senior debt, mezzanine debt, preferred equity, and common equity — ordered by payment priority. Position in the stack determines who gets paid first, who absorbs losses first, and therefore what return each layer should demand.
Reading the stack
The organizing rule is simple: payment priority runs down the stack; risk and required return run up it. In a stylized real estate deal:
- Senior debt — the mortgage or senior secured loan, first claim on the asset, typically 55–70% of the capital, lowest cost. Within senior layers, lien priority can subdivide further, and structured deals slice claims into tranches.
- Mezzanine debt — junior financing above the mortgage, contractual coupon in the low-to-mid teens, secured (in real estate) by a pledge of the ownership entity.
- Preferred equity — an equity position with priority over common for distributions and return of capital, often with a fixed preferred rate; economically adjacent to mezz, legally different in remedies.
- Common equity — last money out, unlimited upside, first loss. The sponsor’s promote and investor waterfall live here.
The stack diagram is the fastest way to understand any offering: where in it does this investment sit, how much capital is beneath it (the cushion that absorbs losses first), and how much above it (the claims that get paid first)? A “9% return” means nothing without that address. Senior debt earning 7% and common equity projecting 15% can both be fairly priced in the same deal — or both mispriced — depending on attachment points and leverage.
What the stack reveals in diligence
Leverage lives in the stack's proportions. Total debt (senior plus mezz) against value sets the equity cushion — a deal that is 85% debt-financed leaves common equity with a sliver of protection and explosive sensitivity in both directions. LTV and DSCR quantify the pressure on the layers above.
Adjacent layers negotiate against each other. Intercreditor and recognition agreements set what mezz can do when senior is unhappy; preferred equity terms set when it can take control from common. For an LP in the common equity, every senior layer is both financing and a party that can take the deal away in distress — the lesson of every downturn’s workout stories.
Products map to layers. Private credit funds own the debt layers; real estate debt funds span mortgage through mezz; value-add equity funds live at the bottom. An allocator can diversify across the stack deliberately — the same building can appear in a client’s portfolio as a loan and as equity, with entirely different risk — once the layer, not just the asset, is the unit of analysis.
FAQ
What is a capital stack in simple terms?
The list of everyone who financed a deal, in the order they get paid back. Lenders at the top of the priority line, owners at the bottom — with returns sized to match.
What's the typical order of a capital stack?
Senior debt first, then mezzanine debt, then preferred equity, then common equity. Priority descends in that order; risk and target return ascend.
Why does position in the capital stack matter?
Because losses hit from the bottom up and payments flow from the top down. Two investments in the same property can have opposite risk profiles depending on their layer.
Is preferred equity debt or equity?
Legally equity, economically debt-like: it has priority and often a fixed return, but no lien and different remedies than a lender — the reason deals use it when loan documents prohibit more debt.
Related terms
Mezzanine Debt · Preferred Equity · Senior Secured Lending · Loan-to-Value (LTV) · Waterfall · Tranche
Educational content only; not investment, tax, or legal advice. Consult qualified professionals regarding your specific circumstances.
