CRE 101 · deweyluong.realtor

The Capital Stack Explained: Who Gets Paid First in a Commercial Deal

Almost no commercial deal is funded by one check. The money arrives in layers — a senior loan at the bottom, maybe mezzanine debt or preferred equity in the middle, and common equity on top — and that order, the capital stack, decides who gets paid first, who gets paid last, and who absorbs the first loss. On the made-up example on this page, a $4,000,000 deal funded with $2,200,000 of senior debt, $1,000,000 of preferred equity, and $800,000 of common equity pays its common equity 3.25% at $280,000 of NOI — and nothing at all at $240,000 of NOI, while the lender is paid in full both times. By Túy “Dewey” Luong, CCIM — Founding Broker, SERHANT. Atlanta · 318 closed sales / $281.2M career volume · 678-707-2498

The worked example uses made-up, rounded numbers to teach the mechanics. The actual layers, rates, and payment priorities of a real deal are set in its loan documents, operating agreement, and any intercreditor agreement — read all of them before pricing any investment. This page is general education, not legal or tax advice.

The four layers, bottom to top

• Senior debt — the bottom layer, paid first: the bank or lender loan, secured by a first lien on the property itself. It takes the lowest return in the stack because it takes the least risk: it is paid before everyone, and if the deal fails it can foreclose on the building. Lenders protect this position with the ratios in DSCR and debt yield.
• Mezzanine debt — borrowed money above the loan: a second layer of debt that sits behind the senior loan. It is usually secured not by the property but by a pledge of the ownership interests in the entity that owns it, and it charges more than senior debt because a wipeout reaches it sooner. Construction and value-add deals stack it on top of the loan measured in loan-to-cost.
• Preferred equity — equity with a debt-like promise: an investor position that receives a fixed preferred return before the common equity sees a dollar, but only after the lenders are paid. It typically cannot foreclose on the property; its remedies run against the ownership interests and the sponsor.
• Common equity — the top layer, paid last: the sponsor's and passive investors' ownership. It has no promised return, absorbs the first loss, and keeps whatever is left after every layer above it is satisfied — which is why it also captures most of the upside. Its scoreboard is cash-on-cash return while the deal runs and the equity multiple when it ends.
• The stack runs in two directions: cash flow and sale proceeds are paid top-down — senior first, common last. Losses run the other way: the common equity is the cushion that burns before any layer above it loses a dollar. Your position in the stack is your real risk, whatever the brochure return says.

Worked example: one $4,000,000 deal, three layers (made-up numbers, labeled as such)

• The deal: a small Gwinnett retail center bought and renovated for a total capitalization of $4,000,000. Stabilized NOI is $280,000 — a 7.0% yield on total cost, the math in yield on cost.
• Senior loan: $2,200,000 — 55% of the stack — at 7.0% interest-only, so debt service is $154,000 a year. Coverage is comfortable on paper: DSCR of 1.82x and a 12.7% debt yield.
• Preferred equity: $1,000,000 — 25% of the stack — at a 10% current-pay preferred return: $100,000 a year, owed after the lender and before the owners.
• Common equity: $800,000 — the last 20% of the stack, and the first-loss cushion for the $3,200,000 of claims above it. The property's value can fall 20% before the senior loan or the preferred position loses anything; the common equity is gone at exactly that point.
• Base case, NOI of $280,000: after the senior loan takes $154,000, $126,000 remains. After the preferred return takes $100,000, $26,000 reaches the common equity — a 3.25% cash-on-cash return on $800,000.
• The stack costs more than the building yields: the blended cost of the senior loan and preferred equity is $254,000 a year on $3,200,000 — 7.94% — against a property yielding 7.0%. That is negative leverage: bought all-cash, the same building would pay 7.0% on the full $4,000,000. Here the layers above are paid more than the property earns, and the common equity makes up the difference.
• Upside case, NOI of $320,000: the senior loan still takes $154,000 and the preferred still takes $100,000 — fixed claims do not grow. The extra $40,000 of income falls straight to the bottom layer: $66,000 to the common equity, an 8.25% cash-on-cash return.
• Downside case, NOI of $240,000: after the senior loan's $154,000, only $86,000 remains against a $100,000 preferred return. The preferred position is short $14,000 — typically accrued, not forgiven — and the common equity receives nothing. The lender, note, was paid in full in all three cases.
• Selling the deal, base case: at a 6.5% exit cap rate, $280,000 of NOI values the property at about $4,307,692. The waterfall repays the senior loan ($2,200,000) and the preferred equity ($1,000,000) first; the common equity receives the remaining $1,107,692 — its $800,000 back plus $307,692 of profit, an equity multiple of 1.38x.
• Selling the deal, downside case: at $240,000 of NOI the same exit cap values the property at about $3,692,308. After the same $3,200,000 of senior and preferred claims, the common equity receives $492,308 — a $307,692 loss, an equity multiple of 0.62x. Same building, same exit cap: the stack turned a $40,000 income swing into a $615,384 swing in what the owners keep.

What to check before you take a position in any stack

• Name your layer and your cushion: the only question that matters is how much value can disappear before your money is touched. For common equity that cushion is zero — you are the cushion. For a lender, it is every layer below the loan.
• Add up the fixed claims above you: debt service plus preferred returns are promises the property must keep in a bad year, not just a good one. Run your layer at a downside NOI — 10% under plan is a fair test — and see what is left.
• Ask whether unpaid returns accrue: a preferred return that accrues when unpaid quietly grows the claim ahead of the common equity every year it is short. The $14,000 shortfall in the example does not vanish; it compounds the distance to the owners' first dollar.
• Read who controls a workout: the senior lender's remedies run against the property, mezzanine and preferred remedies usually run against the ownership interests. In a troubled deal, control sits with the highest layer that is still whole — rarely with the common equity.
• Compare the stack's cost to the property's yield: if the blended cost of the money above you exceeds the yield on cost or the going-in cap rate, leverage is subtracting from your current return even when it adds to the projected exit. That trade can still be right — but price it on purpose, the way you price the exit in exit cap rate.

Cho nhà đầu tư người Việt

Hầu như không thương vụ thương mại nào được tài trợ bằng một tấm séc duy nhất. Tiền đến theo từng lớp — gọi là capital stack: dưới cùng là khoản vay ngân hàng (senior debt), ở giữa có thể là mezzanine debt hoặc preferred equity (vốn ưu đãi), và trên cùng là common equity (vốn chủ sở hữu thông thường). Thứ tự này quyết định ai được trả trước, ai được trả sau cùng, và ai chịu lỗ đầu tiên. Ví dụ giả định trên trang này: một thương vụ tổng vốn $4.000.000 gồm vay ngân hàng $2.200.000 (55%, lãi suất 7%, chỉ trả lãi $154.000/năm), preferred equity $1.000.000 (25%, lãi ưu đãi 10% = $100.000/năm) và common equity $800.000 (20%). NOI ổn định $280.000 (7,0% trên tổng vốn). Sau khi trả ngân hàng còn $126.000; sau preferred equity còn $26.000 cho common equity — tức 3,25% trên số vốn $800.000. Chi phí trung bình của hai lớp trên là 7,94%, cao hơn mức sinh lời 7,0% của tài sản — đó là đòn bẩy âm (negative leverage). Nếu NOI tăng lên $320.000, common equity nhận $66.000 (8,25%); nếu NOI giảm xuống $240.000, common equity không nhận được đồng nào và preferred equity còn thiếu $14.000. Khi bán với cap rate 6,5%, tài sản trị giá khoảng $4.307.692; sau khi trả $3.200.000 cho hai lớp trên, common equity nhận $1.107.692. Bài học: trước khi rót tiền, hãy xác định mình đứng ở lớp nào trong stack và lớp đệm bên dưới mình dày bao nhiêu. Đây là thông tin giáo dục chung, không phải tư vấn pháp lý hay thuế.

Frequently asked questions

What is the capital stack in commercial real estate?

The capital stack is the ordered list of every source of money in a deal, arranged by payment priority: senior debt at the bottom (paid first), then mezzanine debt, then preferred equity, then common equity at the top (paid last). The order also reverses for losses — the common equity absorbs the first dollar of loss, and the senior lender the last. On this page's made-up example, a $4,000,000 deal is stacked as $2,200,000 of senior debt, $1,000,000 of preferred equity, and $800,000 of common equity.

Why does the order of the stack matter?

Because cash flow and sale proceeds are distributed strictly in order, a small change in income lands entirely on the bottom layer. In the worked example, the senior lender is paid its $154,000 in full whether NOI is $320,000, $280,000, or $240,000 — while the common equity's cash flow swings from $66,000 to $26,000 to nothing across the same range. At sale, a $40,000 NOI difference becomes a $615,384 difference in what the owners keep.

What is preferred equity?

Preferred equity is an ownership position with a promised return that ranks ahead of the common equity but behind the debt. It receives its preferred return — 10% a year in the worked example — before the common equity receives anything, and unpaid preferred returns typically accrue rather than disappear. Unlike the senior lender, a preferred equity holder usually cannot foreclose on the property itself; its remedies run against the ownership interests in the deal.

Can leverage in the stack hurt the common equity?

Yes — when the blended cost of the layers above the common equity exceeds the property's yield, leverage subtracts from current return instead of adding to it. In the worked example, the senior loan and preferred equity together cost 7.94% against a property yielding 7.0%, so the common equity earns 3.25% while an all-cash buyer of the same building would earn 7.0%. The leverage still magnifies the exit — a $307,692 gain in the base case, a $307,692 loss in the downside case — which is the trade the bottom layer is actually making.

Capital stack trong bất động sản thương mại là gì?

Capital stack là danh sách mọi nguồn tiền trong một thương vụ, xếp theo thứ tự ưu tiên thanh toán: vay ngân hàng (senior debt) ở dưới cùng và được trả trước, rồi đến mezzanine debt, preferred equity (vốn ưu đãi), và trên cùng là common equity (vốn chủ sở hữu thông thường) được trả sau chót và chịu lỗ đầu tiên. Trong ví dụ trên trang này, thương vụ $4.000.000 gồm $2.200.000 vay ngân hàng, $1.000.000 preferred equity và $800.000 common equity. Với NOI $280.000, common equity nhận $26.000 (3,25%); với NOI $240.000, common equity không nhận được gì trong khi ngân hàng vẫn được trả đủ. Đây là thông tin giáo dục chung, không phải tư vấn pháp lý hay thuế.

Looking at a deal and want to know which layer your money would sit in? Call Túy “Dewey” Luong, CCIM at 678-707-2498 or see SERHANT. Atlanta.