Understanding the Capital Stack: Types of Equity and Debt

Understanding the Capital Stack

When financing commercial real estate, understanding the capital stack is crucial. The capital stack refers to the different layers of financing used to fund a real estate project. Each layer has its own risk and return profile. Knowing these layers helps investors make informed decisions.

Equity is the ownership interest in a property. It represents the amount of capital that the owners have invested. There are two main types of equity: common equity and preferred equity.

Common Equity is the most basic form of ownership. Owners of common equity have voting rights and share in the profits. However, they are the last to get paid in case of a liquidation.

Preferred Equity is a more secure form of investment. Preferred equity holders get paid before common equity holders. They do not usually have voting rights but receive fixed dividends.

Types of Debt

Debt is the borrowed money that must be repaid. It is a less risky form of investment compared to equity. There are several types of debt in the capital stack.

Mezzanine Debt comes after senior debt. It is riskier and has higher interest rates. Mezzanine debt is often used to fill the gap between senior debt and equity.

Importance of the Capital Stack

The capital stack is important because it defines the order of payments. Investors should understand where their investment sits in the stack. This helps them assess the risk and potential return.

Making Informed Decisions

Understanding the capital stack helps investors make better decisions. They can choose the right type of investment based on their risk tolerance and return expectations. This knowledge is also crucial for structuring deals and negotiating terms.

By being aware of the different layers, investors can diversify their portfolios. They can balance their investments by mixing different types of equity and debt. This strategy can help in achieving a more stable and profitable investment.