Explaining the Capital Stack: What Investors Need to Know

Confused about how the capital stack works in a real estate deal? Here’s a clear, jargon-free explanation of what it means and why it matters.

If you’re investing passively in a real estate syndication, understanding the capital stack is one of the most important ways to protect yourself—and understand your potential return.

Here’s a simple breakdown of what the capital stack is, how it works, and what it means for you.

What Is the Capital Stack?

The capital stack describes how a real estate deal is funded—from senior debt (least risky) to common equity (most risky, most potential return).

Each “layer” has a different risk/reward profile.

Typical Capital Stack Layers in a Syndication:

1. Senior Debt

   • Usually a bank or lender (Fannie, Freddie, bridge lender)

   • First in line to be repaid

   • Lowest risk, but no equity upside

   • Usually makes up 60–75% of the deal’s total capital

2. Preferred Equity or Mezzanine Debt (Optional)

   • Gets paid before common equity

   • Often earns a fixed return

   • Adds complexity, but can be helpful in higher-leverage deals

3. Common Equity (This Is You, the Passive Investor)

   • Ranks behind debt and preferred equity

   • Shares in upside after preferred returns

   • Higher risk, but greater potential reward

   • Typically where limited partners (LPs) and the general partner (GP) invest

Why It Matters

As a passive investor, you’re usually in the common equity layer, alongside or just behind the GP. That means:

• You don’t get paid until debt (and sometimes preferred equity) is covered

• But you do participate in the upside once the property performs

• You should understand your position clearly before investing

Key Questions to Ask:

• “Where do I sit in the capital stack?”

• “Is there preferred equity or mezz debt ahead of me?”

• “What happens to my returns if the deal underperforms?”

Final Thought
You don’t have to become a capital markets expert—but knowing where your money sits in the capital stack helps you evaluate your potential return, your exposure to risk, and the sponsor’s structure.

Ask the question. The right sponsor will answer it clearly.