The 'Capital Stack' in Commercial Real Estate
In commercial real estate investing, the "capital stack" refers to the various sources of capital that are used to finance a property. The breakdown of each part of the capital stack typically includes the following components, listed in order of priority in case of default or liquidation:
Senior Debt: This is typically the first source of financing and represents the primary source of funding for most commercial real estate investments. Senior debt is secured by the property and has the highest priority in terms of repayment in the event of a default or liquidation.
Mezzanine Debt: Mezzanine debt sits between senior debt and equity in the capital stack. It typically carries a higher interest rate than senior debt and is secured by a pledge of the borrower's equity interest in the property. Mezzanine debt may be used to provide additional funding for a property or to refinance existing debt.
Preferred Equity: Preferred equity represents an ownership interest in the property but is subordinate to debt. It typically carries a fixed rate of return and may have priority over common equity in terms of cash flow and distribution.
Common Equity: Common equity represents the ownership interest in the property that remains after all debt and preferred equity has been satisfied. Common equity investors may receive returns through cash flow from operations, appreciation in the property value, or a combination of both.
Each component of the capital stack has different risk and return characteristics, and investors will typically choose a mix of these sources to fund their investment depending on their investment goals, risk tolerance, and market conditions.
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