A capital stack is simply the funding plan for a property: who put in money, what form that money took, what each layer is promised, and who gets paid first when cash shows up. You can think of it as a priority ladder. The layers higher up the stack accept a lower return because they have a tighter claim on the property’s cash flow and collateral. The layers lower down demand a higher return because they absorb the misses when reality falls short.
In real estate, this matters because most deals are not funded with a single pot of money. They’re funded with a blend—usually a senior loan plus one or more forms of equity—and the blend drives both the return profile and the fragility of the deal.
Sources & Uses
Before you talk about “the stack,” you need the sources-and-uses picture: how much capital is required, and where it’s going.
On the “uses” side, you’re paying the purchase price and closing costs, and you’re usually setting aside real cash for renovations and working capital. Working capital is a buffer for timing gaps and surprises, and a common rule of thumb is roughly 0.5% to 2% of purchase price depending on the business plan and how tight everything already is.
On the “sources” side, you’re listing where the money comes from: senior debt, maybe subordinate debt, and equity (which itself can be split into different buckets).
Senior Debt
Senior debt is the first claim on the property. The lender gets paid before anybody else, and if the deal fails, the lender has the cleanest path to take control of the collateral.
Lenders also shape the stack indirectly through requirements that feel small until you’re wiring money. Escrows and impounds are a good example. Many lenders want property tax and insurance escrows, and they often want an initial deposit so the escrow account has a cushion.
Senior debt is priced and limited by underwriting constraints (DSCR, LTV, debt yield, etc.), but from a stack standpoint the key point is priority: debt service comes out before equity distributions, and that single fact controls the entire risk posture of the deal.
Subordinate Debt
Once you’ve maxed out what a senior lender will do, there’s often still a gap between total uses and available equity. That gap can be filled with higher-cost layers that sit behind the senior lender—mezzanine debt, preferred equity, or other structured capital.
These layers exist because the sponsor wants more leverage than the senior lender will offer, without raising as much common equity. They can be useful in very specific situations, but they also tighten the deal. The more fixed claims you stack above common equity, the less room you have for normal operating variance.
Even when the documents call a layer “equity,” if it has a contractual return and tight remedies, it tends to behave like debt in practice.
Common Equity, Preferred Returns, Promotes, & Waterfalls
Common equity is the residual claim. After operating expenses and debt service are paid, equity gets whatever is left.
In smaller deals, common equity is often just the owner’s down payment. In syndicated deals, common equity usually splits into sponsor equity and investor equity, and then the distribution rules determine how that equity actually behaves.
In many syndicated structures, investors receive a preferred return that gives them priority over early cash flow. A common example is an 8% preferred return applied to the current capital balance. If the capital balance is $1,000,000, the preferred return accrual for the year is $80,000.
Preferred returns often accrue if unpaid (cumulative), and sometimes they compound depending on how the agreement defines the capital account mechanics. The important operational reality is simple: if the property doesn’t throw off enough cash, the pref doesn’t magically appear. It becomes another obligation the deal has to catch up on before the sponsor participates meaningfully.
The sponsor’s “promote” is the performance-based share—an incentive structure where the sponsor receives a higher portion of proceeds after certain hurdles are met. Many deals step the split over time (for example, a 70/30 split after the pref, shifting at higher return tiers).
An Example
Assume a syndication starts with a $1,000,000 capital balance and an 8% preferred return. In year one, the property produces $100,000 of distributable cash flow.
- Investors are owed $80,000 based on the pref.
- The remaining $20,000 is split 70% to investors / 30% to sponsor, leaving the capital balance reduced (in this example framework) to $986,000.
In year two, assume a refinance generates $100,000 of distributable proceeds. Many agreements route refinance (and sale) proceeds first toward returning investor capital until the capital balance is paid back. So that $100,000 goes to investors, dropping the capital balance from $986,000 to $886,000.
Fast forward to a sale. If sale proceeds are $1,200,000 and the remaining capital balance is $200,000, investors typically receive (1) the current-year preferred return on that remaining balance and (2) a return of that remaining $200,000 before splits apply to the residual.
That sequence—pref, return of capital, then promote tiers—is the waterfall translating the capital stack into actual dollars.
Influence Based on Say
One piece that gets overlooked: each layer comes with a say.
Senior lenders have covenants, cash management rights, escrows, reporting requirements, and remedies. Preferred equity and mezzanine capital often have their own control provisions, sometimes including step-in rights or forced sale/refinance triggers. The more layers you add, the more you are negotiating how control shifts if performance deteriorates.
This becomes especially relevant when a deal is under stress. If the property is barely covering debt service, the theoretical upside split is irrelevant. What matters is who has the ability to force decisions.
Conclusion
If you want to understand how a deal will actually behave, look at the capital stack before you look at the returns. Pay attention to who has a fixed claim on cash flow, who gets paid first when money comes in, and how much room is left when things don’t line up perfectly. That structure tells you far more about risk than a projected IRR ever will.