Understanding The Capital Stack

Eric Wilson

Managing Partner

January 1, 2024

5 min read

Eric Wilson

Managing Partner

January 1, 2024

5 min read

One of the critical aspects of investing in a multifamily syndication is understanding the 'capital stack', a key concept that delineates the hierarchy of capital invested in a project. In this blog, we will explore what a capital stack is, its components – including senior debt, mezzanine debt, preferred equity, and common equity – and how sponsors determine its structure, along with the pros and cons of different capital stack arrangements.

Understanding the Capital Stack

The capital stack represents the layered structure of capital invested in a real estate project, detailing the order of priority in which investors will be repaid and earn returns. This stack is crucial in determining the risk and potential return for each type of investment within a project.

Components of the Capital Stack

1. Senior Debt

At the base of the capital stack lies senior debt, which is typically the most substantial portion of the financing.

  • Characteristics: This is the primary loan secured by the property, often a mortgage. It has the highest priority in terms of repayment and carries the lowest risk since it's secured by the property itself.
  • Investor Implication: Investors in this layer have the lowest risk but also the lowest potential returns, usually in the form of fixed interest payments.

2. Mezzanine Debt

Sitting above senior debt is mezzanine debt, a hybrid of debt and equity financing.

  • Characteristics: Mezzanine debt is generally unsecured and provides a higher rate of return due to its increased risk. It's subordinate to senior debt but takes precedence over equity investments.
  • Investor Implication: This layer is riskier than senior debt but offers higher potential returns. It's attractive to investors looking for higher yields and willing to accept more risk.

3. Preferred Equity

Above mezzanine debt lies preferred equity, which blends features of both debt and equity.

  • Characteristics: Preferred equity holders receive fixed dividends and have a higher claim on assets and earnings than common equity investors, but below all debt holders.
  • Investor Implication: These investors typically receive regular dividends and may have some decision-making power in the project.

4. Common Equity

At the top of the capital stack is common equity.

  • Characteristics: Common equity holders are the last to get paid in the event of a sale or refinance, bearing the highest risk. However, they also enjoy the highest potential returns.
  • Investor Implication: This is ideal for investors who are risk-tolerant and seeking higher long-term returns.

Determining the Capital Stack

Sponsors, or those who manage the syndication, carefully determine the capital stack based on several factors:

  • Project Risks and Returns: The perceived risk and expected returns of the project influence the mix of debt and equity.
  • Market Conditions: Prevailing interest rates and real estate market trends play a significant role.
  • Investment Strategy: The project’s timeline, expected income generation, and value-add opportunities guide the structuring of the capital stack.
  • Investor Appetite: The preferences and risk tolerance of potential investors are also a determining factor.

Pros and Cons of Different Structures

Different capital stack structures offer varying levels of risk and return.

  • Equity-Heavy Structures: These are generally lower risk but offer limited upside potential. They are suitable for projects with predictable cash flows.
  • Debt-Heavy Structures: While riskier and dependent on the property’s performance, these structures offer higher potential returns and are fitting for value-add or opportunistic strategies.
  • Balanced Structures: A mix of debt and equity can balance risk and return, appealing to a broader range of investors.

The Leverage Effect

Leverage is risk in an investment. The more leverage, the more perceived risk an investment has. To illustrate the leverage effect we have two scenarios below. Both are considered highly levered to illustrate the dramatic impact that leverage has on both return potential and risk.

In the scenarios below, the two projects both cost $20,000,000. One of them is levered to 85% while the other is levered to 70%. Both scenarios are sold for $25,000,000. The 85% leverage scenario may seem attractive due to the less equity required and thus greater return on equity. However, we will also see how dangerous this can be.

If we change the sell amount to represent a 5% market reduction ($19,000,000), we can see that the 85% levered scenario lost 79% of their equity while the 70% leverage scenario only lost 35% of the equity. And while it's never a good thing to lose capital, given these two options, losing less is far more attractive.


The capital stack is a fundamental concept in multifamily syndication, providing a framework for understanding the various layers of investment, each with its own risk and return profile. Sponsors must skillfully balance the capital stack to align with the project's goals, market conditions, and investor expectations. For investors, understanding where you fit in the capital stack is crucial to aligning your investment with your risk tolerance and return objectives. As multifamily syndication continues to evolve, so too does the sophistication in structuring and managing the capital stack for optimal performance and risk management.