The capital stack is every layer of money that funds a commercial real estate project, ranked by who gets repaid first. Senior debt sits at the bottom with first claim on the property and the lowest cost. Mezzanine debt and preferred equity sit in the middle. Common equity sits on top, takes losses first, and keeps the upside. Each layer higher in the stack carries more risk and expects a higher return.

The 4 layers

Senior debt is the first mortgage, secured directly by the property. It has first priority on cash flow and on proceeds from a sale or foreclosure. Because it carries the least risk, it is the cheapest capital in the stack. Banks, life companies, agency lenders, CMBS lenders, and debt funds provide it.

Mezzanine debt is a loan secured by a pledge of the ownership interests in the entity that owns the property, not by the property itself. If the borrower defaults, the mezzanine lender can foreclose on those interests, usually through a faster process than a mortgage foreclosure, and take control of the owning entity subject to the senior loan.

Preferred equity is an equity investment in the owning entity with a priority return and priority return of capital ahead of common equity. It is not a loan, so its remedies come from the partnership or operating agreement, such as the right to take over management or force a sale if the preferred return is not paid.

Common equity is the sponsor's and investors' capital. It is paid last and absorbs losses first, and in exchange it receives the remaining cash flow and profit after every layer below is satisfied.

A hypothetical example

Consider a hypothetical $50,000,000 acquisition. A senior lender provides $30,000,000, or 60% of cost. A mezzanine lender adds $7,500,000, bringing total debt to 75%. A preferred equity investor contributes $5,000,000, and the sponsor and its investors provide the remaining $7,500,000 of common equity.

If the property later sells for $45,000,000, the senior loan and mezzanine loan are repaid in full from the first $37,500,000. The preferred equity receives its $5,000,000 plus any accrued return from what remains, and common equity absorbs the loss. If the property sells for $65,000,000 instead, the fixed layers receive their contractual amounts and common equity keeps the profit.

Why sponsors use subordinate capital

Senior lenders cap proceeds through loan-to-value, loan-to-cost, and coverage tests. When the senior loan and the sponsor's equity do not cover the full cost, mezzanine debt or preferred equity fills the gap. It lets a sponsor complete a larger acquisition or development, keep more ownership than a joint venture would allow, or return equity without selling. The trade-off is cost and control: every dollar of subordinate capital is more expensive than senior debt and adds another party with rights.

When a property carries both senior debt and mezzanine debt, the lenders sign an intercreditor agreement. It sets each lender's rights to cure defaults, purchase the other's position, approve transfers, and control decisions in a workout. Many senior lenders prohibit subordinate mortgage debt, and some restrict mezzanine debt or preferred equity, so the structure has to be approved at the senior level before it is layered in.

Mezzanine debt or preferred equity?

Mezzanine debt is usually cheaper and has clearer, faster remedies through a pledge of the ownership interests. Preferred equity can be available where a senior lender will not permit mezzanine debt, and it may be more flexible on structure, though its remedies depend on the negotiated operating agreement. The choice depends on the senior lender's rules, the amount needed, the hold period, and how much control the sponsor is willing to share.

Building the right stack

The best capital stack delivers the proceeds the plan needs at the lowest blended cost without giving away control or flexibility that the business plan depends on. Capital Partners places senior debt, mezzanine debt and preferred equity, and joint-venture equity for commercial real estate from $1M to $100M. Use the loan sizing calculator to find the senior loan a property supports, then submit the deal to structure the rest.