4/13/2022

Real Stack Of Cash

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Intro – What Is the Capital Stack?

Senior Debt…

Mezzanine Debt…

For more on mezzanine debt, how it is used, and the particulars of investing at this point in the capital stack, please refer to this article.

Real Stacks Of Cash

Preferred Equity…

Preferred equity and mezzanine debt fulfill similar functions in the capital stack: forms of “bridge financing” – methods of financing short-term capital needs to fill a gap between the debt and equity components of the overall project’s capitalization. Both entail some recourse provisions for the holder of the position.

For more on the benefits of preferred equity real estate investing, and how it is used in the capital stack, please review this article.

Create an EquityMultiple account and view live investments across the real estate capital stack

Common Equity…The Top of the Capital Stack

…is the riskiest and most profitable portion of the real estate capital stack. Typically the GP investor (the developer or sponsor)

Though common equity is generally the highest-risk, highest-upside portion of the capital stack, not all common equity investments are created equal with respect to risk/return profile. A healthy preferred return written into an investment agreement can mitigate some downside risk for passive investors (we typically strive to negotiate attractive preferred returns on behalf of EquityMultiple investors).

Other qualitative and quantitative attributes of an equity investment can impact the attendant risk and potential upside. Some of these factors include:

Capitalization Rates: how conservatively the exit (or “going out”) cap rate is modeled. For more, please review this article.
Market: Generally, gateway markets like New York City or San Francisco will offer more downside protection (less risk) but, accordingly, less upside potential. This is because dense, affluent knowledge centers such as these enjoy robust and diverse rental demand but are hence home to some of the most competitive real estate markets in the world, dampening return potential. It’s no coincidence that markets like New York City become particularly appealing for global investors in times of economic volatility. Conversely, lesser-known secondary and tertiary markets may offer more robust demand growth opportunities, and upside for commercial real estate investment, but greater risk due to less established, less diverse local economies.
Business Plan: Equity investments can offer an array of risk/return profiles based on the underlying strategy. The amount of capital expenditure needed, the complexity of the project, and the in-place rent roll and cash flow all impact the risk and potential return of an investment. For more on this topic, please review this article.

Such considerations matter for investments throughout the capital stack. However, such attributes of an investment can magnify risk and return potential for a common equity investment to a greater extent, as passive investors have fewer protections but can enjoy uncapped upside.

The capital stack of a prior preferred equity investment, showing total capitalization and relative proportions of debt and equity capital.

Conclusion – The Capital Stack and Your Portfolio

Up Next >>> Commercial Real Estate Due Diligence

Shareby EQUITYMULTIPLE StaffEquityMultiple's team features real estate industry veterans, technology-driven analysts, and dedicated armchair economists.

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