David Ooi, Director – Capital & Business Advisory
In this guide, we will share insights into the dynamics of the capital stack as it relates to Commercial Real Estate Debt. We aim to explain layers within the capital stack, the role of equity and its position within the risk/repayment hierarchy.
What is the Capital Stack?
In the context of Commercial Real Estate Debt, the capital stack refers to the tiers of financing sources used to fund a project. The capital stack is typically depicted as a vertical arrangement, with each layer representing a different type of capital or financing:
Senior Debt
Senior debt represents the foundation and is the least risky and least expensive form of capital. It is often provided by traditional lending institutions and is secured by a mortgage over the property.
Mezzanine Debt
Mezzanine debt falls between senior debt and equity in terms of risk and return. It offers higher potential returns than senior debt but ranks behind it in repayment priority. Mezzanine debt holders receive interest payments and are repaid after senior debt.
Preferred Equity
Unlike debt, preferred equity is not secured but it ranks ahead of ordinary equity in repayment. Preferred equity investors may receive regular distributions and share in profits but carry more risk than senior debt holders.
Ordinary Equity
Represents the lowest-ranking layer of the capital stack. Equity investors bear the highest risk but also have the potential for the highest returns. They're the owners of the property and are repaid last in the event of default.
Why Understanding the Capital Stack Matters?
Investors must be able to understand the capital stack to assess risk versus reward accurately. Knowing their position within the repayment hierarchy enables informed decision-making and risk management. Whether pursuing capital growth or income generation, understanding the capital stack is crucial for building a well-considered and diversified investment portfolio.
At Prime, we offer opportunities for capital preservation and portfolio diversification through commercial real estate debt. Speak with one of our team members today to explore how we can assist you in achieving your investment objectives.
