For property investors and real estate investors, the capital stack refers to the different layers of funding and financing obtained to acquire a property. The capital stack, which consists of different layers can include any of the following – Common Equity, Preferred Equity, Mezzanine debt, and Senior debt.
Depending on the investor and their financial portfolio, the capital stack would look different for each case or investor.
In this case, we see that there are four layers to the capital stack i.e., Common Equity, Preferred Equity, Mezzanine debt, and Senior debt.
If this structure is followed, it would mean that those at the top, common equity have a higher risk and less priority over those capital structures to follow.
Bottom capital stacks, such as Mezzanine debt and Senior debt have a higher priority and lower risk, as they can enjoy better cash flows and asset allocation.
The capital stack is a structure that’s used to ensure that in the event a company or investor defaults on their repayments, or files for bankruptcy, the underlying capital stacks will receive first claim and priority in obtaining their initial cash investments.
Usually, senior debt will have the highest priority or first claim on the remaining value of an investment property in the event of insolvency.
Afterward, mezzanine debt would then receive a second claim, followed by preferred equity investors and common inquiry investors.
On the other hand, oftentimes it’s been found that those levels higher at the top could enjoy better capital gains and returns if an investor does not default on the loan or the investment. They do however have higher risks, but for lower-lying levels, they are only offered the initial investment and interest repayments.
While this example refers to property investment, it’s common that the capital stack can be found in different areas of the financial and investment world.
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