The term “Capital Stack” is comprised of the total capital invested in a project. In CRE (commercial real estate), these “stacks” typically include: 






	
Common Equity


	
Preferred Equity


	
Mezzanine Debt


	
Senior Debt






Each of these investment levels comes with its own unique risk and rewards. Typically, higher positions in the capital stack earn higher expected returns due to their higher risk.




One of the most important parts of investing in CRE is performing due diligence. This includes determining the place you want to be on the capital stack. Understanding the capital stack structure is a key component to building a diversified portfolio.




Common Equity




At the top of the capital stack, this layer contains the most risk of all the layers. When an investor invests in common equity of a project, they are taking an ownership stake in the project. The risk level at this layer is greater because the sponsors of the project only get paid after all the other positions in the capital stack are repaid. To compensate investors for this increased risk, equity investors (sponsors) have a pro-rata interest in all the upside of the project after the other capital stacks have been paid.




Preferred Equity




This is another form of equity in a project, and it is the next in line in the capital stack. Preferred Equity is senior to common equity but subordinated to senior debt. Preferred Equity allows investors to receive payments ahead of common equity holders, as well as some percentage (profit split) of the total capital gain of a project. It does contain some measure of seniority to common equity, both the expected risk and potential upside is slightly lower than common equity.




Mezzanine Debt




The first form of debt in the capital stack is called mezzanine debt. It contains seniority to equity positions (common equity and preferred equity) but is subordinate to senior debt. Mezzanine debt investors demand a higher rate of return than senior debt investors due to their unsecured position, meaning that they only get repaid after all senior obligations have been satisfied. 




Senior Debt




This is the “foundation” of the capital stack, and typically most of the stack. Senior debt is generally secured by the property, which serves as collateral for the loan. The risk of this category is typically considered to be the lowest of all of the layers in the stack due to its security interest in the collateral. Senior debt receives ongoing interest payments before the investors in the higher layers in the capital stack get paid. Because of the relative security, senior debt has the lowest level of reward when the interest payments are set.




Commercial real estate capital stack offers a wide variety of investment opportunities. Those different layers of risks/rewards provide the ability to create an investment portfolio to meet Inventor’s goals.




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