What is a capital stack?
A capital stack is the layered structure of debt and equity used to buy or build a property, ordered by who gets paid first from cash flow and from a sale or refinance. The layers at the bottom are paid first and carry the least risk; the layers at the top are paid last and lose their money first.
The order is set by contracts, not custom: the mortgage, any mezzanine loan agreement, the intercreditor agreement and the ownership entity’s operating agreement. When you invest in a syndication, the offering documents spell out which layer you are buying.
The four layers of the capital stack
Most multifamily stacks use some combination of four layers: senior debt, mezzanine debt, preferred equity and common equity. Simple deals have only senior debt and common equity; larger or more aggressive deals fill the gap with the middle two.
| Layer | What secures it | When it gets paid | Risk and return |
|---|---|---|---|
| Senior debt | First mortgage or deed of trust on the property | First, from cash flow and from sale or refinance | Lowest risk, lowest return |
| Mezzanine debt | Pledge of the ownership interests in the borrower | After senior debt | Higher rate than senior debt |
| Preferred equity | Rights in the operating agreement | After all debt, before common equity | Fixed preferred return, little upside |
| Common equity (GP and LP) | Ownership, no security | Last | Highest risk, keeps the upside |
Senior debt: the foundation
Senior debt is the first mortgage loan, secured directly by the property and paid before anyone else. If the borrower defaults, the senior lender can foreclose on the real estate itself.
On apartment buildings senior debt usually comes from an agency lender, a bank, a life company or a bridge lender, and it is sized by loan-to-value and DSCR limits. The senior lender’s covenants, maturity date and any rate cap drive the terms of the whole deal, so read them carefully; our apartment building loans and bridge loan guides cover the loan types.
Mezzanine debt: secured by the equity, not the property
Mezzanine debt is a loan to the owners of the property-owning entity, secured by a pledge of their membership or partnership interests instead of a mortgage. It sits behind senior debt and ahead of all equity.
Because the collateral is personal property under Article 9 of the Uniform Commercial Code, a mezz lender forecloses by selling the pledged interests rather than foreclosing on the building. UCC 9-610 requires every aspect of that sale to be commercially reasonable, and UCC 9-612 treats notice sent at least 10 days before the sale as reasonable in a non-consumer deal. The winning bidder takes control of the entity that owns the building, and the senior loan stays in place.
An intercreditor agreement between the senior and mezz lenders sets the rules: the mezz lender’s right to cure senior defaults, its option to buy the senior loan, who counts as a qualified transferee after a foreclosure and what the mezz lender cannot do without senior consent. For a side-by-side comparison with preferred equity, see our preferred equity vs mezzanine debt guide.
Preferred equity: ahead of common, behind all debt
Preferred equity is an ownership investment in the deal entity that is paid a fixed preferred return, and usually its capital back, before common equity gets anything. It is not a loan, so its protections come from the operating agreement rather than a lien.
Typical rights include taking over management or forcing a sale if the preferred return isn’t paid or the deal reaches a redemption date. Some pref is paid currently from cash flow; some accrues, which means an unpaid balance can grow and push common investors further back.
Common equity: the GP and LPs
Common equity is the first-loss, last-paid layer, and it owns whatever is left after every other layer is paid. In a syndication it is split between the sponsor as general partner and passive investors as limited partners.
Inside common equity the split is set by a waterfall, often a preferred return to LPs and a promote to the GP. That LP preferred return is not the same thing as a preferred equity layer; it is only a priority within common equity. Our GP vs LP and real estate waterfall guides walk through those terms.
Attachment points: where each layer starts and ends
An attachment point is where a layer begins in the stack, as a share of property value, and the detachment point is where it ends. A layer starts losing money once value falls below its detachment point and is wiped out if value falls below its attachment point, which makes these two numbers the quickest way to compare risk.
| Layer (in the $20M example) | Amount | Covers value from | Last dollar at |
|---|---|---|---|
| Senior debt | $12,000,000 | 0% | 60% |
| Mezzanine debt | $2,000,000 | 60% | 70% |
| Preferred equity | $2,000,000 | 70% | 80% |
| Common equity | $4,000,000 | 80% | 100% |
Worked example: a $20 million deal through three outcomes
Say a $20,000,000 apartment purchase is funded with $12,000,000 of senior debt at 6.0% interest only, $2,000,000 of mezzanine debt at 11.0%, $2,000,000 of preferred equity at a 12.0% current return and $4,000,000 of common equity. The building produces $1,300,000 of NOI a year and is sold after five years, with no selling costs to keep the math simple.
Each year senior interest is $720,000, mezz interest $220,000 and the pref payment $240,000. That leaves $120,000 for common equity, a 3.0% cash yield. Senior DSCR is 1.81x, but coverage through the mezz loan is only 1.38x.
At a $25,000,000 sale, every layer ahead of common is repaid and common equity receives $9,000,000. Add five years of $120,000 and common gets $9,600,000 on $4,000,000, a 2.40x equity multiple and an IRR of about 19.85%. Unlevered, the whole $20,000,000 would earn 1.575x and about 10.55%.
At $17,000,000, debt and pref are still repaid in full, but common gets back only $1,000,000 plus $600,000 of cash flow: $1,600,000, or 0.40x. At $14,500,000, pref recovers $500,000 of its $2,000,000 and ends at 0.85x, while common ends at 0.15x with nothing from the sale. Senior debt and mezz earn their full 6.0% and 11.0% in all three cases.
| Layer | Invested | $25M sale | $17M sale | $14.5M sale |
|---|---|---|---|---|
| Senior debt (6.0%) | $12,000,000 | $15,600,000 (1.30x) | $15,600,000 (1.30x) | $15,600,000 (1.30x) |
| Mezzanine (11.0%) | $2,000,000 | $3,100,000 (1.55x) | $3,100,000 (1.55x) | $3,100,000 (1.55x) |
| Preferred equity (12.0%) | $2,000,000 | $3,200,000 (1.60x) | $3,200,000 (1.60x) | $1,700,000 (0.85x) |
| Common equity | $4,000,000 | $9,600,000 (2.40x) | $1,600,000 (0.40x) | $600,000 (0.15x) |
| Whole deal, unlevered | $20,000,000 | $31,500,000 (1.575x) | $23,500,000 (1.175x) | $21,000,000 (1.05x) |
How the capital stack changes leverage and returns
Every layer below you is leverage on your position, so more debt and pref make common equity more volatile in both directions. In the example a 25% rise in value gives common a 2.40x multiple, while a 15% drop leaves common with 0.40x even though the property as a whole still returned 1.175x.
The break points are simple subtraction. Common equity loses its sale proceeds below $16,000,000, preferred equity is impaired below that same $16,000,000, mezz below $14,000,000 and senior below $12,000,000. Thin current cash flow to common, like the 3.0% here, also leaves little margin if NOI slips or a floating rate rises.
What passive investors should check
Before you invest, find out exactly which layer you are buying and what sits ahead of you. These questions cover most of the risk.
- Total leverage: senior plus mezz plus pref as a share of value, not just the senior loan-to-value
- Whether any pref accrues and compounds, and what happens if it isn’t paid
- Maturity dates of every layer, and whether they line up with the business plan
- Fixed or floating senior rate, and the cost and term of any rate cap
- Coverage through all debt, not just senior DSCR
- Remedies of mezz and pref holders: can they take control from the GP?
- Whether the senior loan documents allow the mezz or pref layer at all
- Capital call provisions and whether common investors can be diluted
- How much of its own money the sponsor puts into common equity
How this works for a 5+ unit apartment building
For a 5+ unit apartment building, the stack is often just senior debt and common equity, with mezz or preferred equity added on larger value-add or bridge-financed deals to shrink the equity check. The middle layers cost more than senior debt, so they only help common investors if the business plan raises NOI by more than that cost.
Many senior lenders limit or prohibit additional debt, so a deal that needs extra capital may use preferred equity instead of mezz. Look hard at the cap rate the plan assumes at exit, because in the example a modest change in exit value moves common equity from 2.40x to 0.40x.
Investing in multifamily with Skyline
Skyline Capital Investments is a multifamily sponsor that buys apartment buildings with five or more units. Our Investor Network shares educational material like this guide and lets members know about opportunities that may suit them.
Specific offerings are made only to eligible investors through the offering documents, which describe the full capital stack of each deal, and most are limited to accredited investors. Join the Investor Network and ask us how a deal is structured before you decide.
