How it works
The stack describes two orderings that always run in the same direction: priority of payment and expected return. Whoever gets paid first accepts the lowest return, because being paid first is what they are buying. Whoever gets paid last demands the highest, because they absorb the first losses. Every position in the stack is a different trade between those two things, and understanding a deal means knowing where each participant sits.
Payments flow through the stack in order, every period. Net operating income first satisfies senior debt service. What remains pays mezzanine debt, then any preferred equity return. Only what is left after all of that reaches common equity. In a strong year every layer is paid and the residual to common equity is large. In a weak year the senior lender is paid in full while common equity receives nothing, which is not a malfunction but the design.
Losses run in the opposite order. If the property is sold for less than the total capitalization, common equity is wiped out before any subordinate lender loses a dollar, and subordinate lenders are wiped out before the senior lender. This is why the cushion beneath a position matters more than the headline leverage: a mezzanine lender at 65% to 80% of value has 20% of value beneath them, and a 20% decline erases their entire position while the senior loan remains whole.
Structuring a stack is fundamentally about filling a gap. The senior lender sizes to whatever constraint binds, typically 60% to 70% of value. The sponsor has a certain amount of equity. Whatever sits between is the gap, and the choice of how to fill it (more common equity, mezzanine debt, preferred equity, or a joint venture partner) determines who controls the asset, who is paid first, and how the upside is split.
Worked example
A $10,000,000 acquisition funded with a $6,500,000 senior loan, $1,500,000 of mezzanine debt at 11%, and $2,000,000 of common equity. The property produces $600,000 of NOI, with senior debt service of $493,000.
| Step | Calculation | Result |
|---|---|---|
| Cash flow after senior debt service | $600,000 − $493,000 | $107,000 |
| Mezzanine interest due | $1,500,000 × 11% | $165,000 |
| Shortfall to the mezzanine lender | $107,000 − $165,000 | −$58,000 |
| Cash to common equity | nothing remains | $0 |
| Value at which mezzanine is fully wiped out | $10,000,000 × 0.65 | $6,500,000 |
The property covers its senior loan comfortably at 1.22x and still cannot pay the mezzanine lender in full. The $58,000 shortfall accrues, common equity receives nothing, and the sponsor's control is at risk if the mezzanine loan goes into default. A 35% decline in value (from $10 million to $6.5 million) wipes out both the $2,000,000 of common equity and the entire $1,500,000 mezzanine position while leaving the senior lender whole. That asymmetry is what each layer is pricing.
How it compares
| Position | Typical share of capitalization | Return and rights |
|---|---|---|
| Senior mortgage | 55% – 70% | Lowest return; first claim on cash flow; secured by the property |
| Mezzanine debt | 10% – 20% | Higher fixed return; secured by equity interests, not the property |
| Preferred equity | 10% – 20% | Fixed preferred return before common; equity, not debt |
| Common equity | 20% – 35% | Last paid, first to lose, unlimited upside, controls the asset |
Common mistakes
- Judging leverage by senior LTV alone
- A 65% senior loan with 15% mezzanine behind it is 80% total leverage. The senior lender's position is unchanged; the sponsor's cushion is not.
- Assuming subordinate capital is cheaper than equity because it is called debt
- Mezzanine at 11% to 14% is expensive money. It is chosen for control and dilution reasons, not because it is inexpensive.
- Ignoring intercreditor terms
- What a mezzanine lender may do on default, and what the senior lender may block, determines who actually controls the asset in distress.
Frequently asked questions
- What is a capital stack in real estate?
- The layered structure of all capital funding a property, ordered by repayment priority: senior debt first, then subordinate debt such as mezzanine, then preferred equity, then common equity last. Each layer accepts a return commensurate with where it sits.
- Who gets paid first in a capital stack?
- The senior lender. Cash flow satisfies senior debt service before any subordinate debt, preferred return or distribution to common equity, and in a loss the order reverses: common equity absorbs the first losses.
- Why use mezzanine debt instead of more equity?
- Because it fills the gap between the senior loan and the sponsor's available equity without diluting ownership or ceding control. It is expensive (commonly 11% to 14%), but it preserves the sponsor's share of the upside and carries no permanent ownership claim.