Understanding Capital Stacks

Have you wondered how investors get paid in multifamily syndication deals? Perhaps you’ve heard the term Capital Stack or wondered why some investors receive distributions before others.

 

Understanding the order in which returns are paid in a real estate syndication will enable you to select deals in which the capital stack is favorable toward your investing goals.

 

Understanding Capital Stacks in Real Estate Syndication

In multifamily real estate, the term “capital stack” refers to the layers of financing and investments that make up the total capital structure of the deal. In other words, it is the order in which distributions are paid to debt and equity partners.

 

These stacks define the risk-reward profile of each layer. Those at the top carry the lowest risk (and lowest returns) and receive distributions first when cashflow is available. That cashflow continues down the stack, paying their investors respectively and proportionally to the risk they carry.

 

Such structures are outlined in each deal’s PPM (Private Placement Memorandum.) It explains when and how each partner gets paid during the project. Let us take a closer look at these partners in priority order within the stack.

 

Senior Debt

At the top of the stack is the senior debt, which are traditional loans financing the property issued by banks or financial institutions. They have a low rate-of-return, typically around 2-4%, but are also paid first.

 

Mezzanine Debt

The next layer in the stack is mezzanine debt and is most commonly a bridge loan or a second mortgage. Such debt can be secured by the Sponsoring Team to increase their leverage or reduce the amount of equity needed to fund the project.

 

Preferred Equity

After the loans, expenses, and fees are paid, Preferred Equity partners are next in the stack to receive a distribution from the cashflow. Typically a large investment is required to reside in this tier with a limited number of positions available.

 

Common Equity

Next in the stack are Common Equity partners, and can be divided into Class A and Class B. Such investors are typically participating in capital returns and cashflow distributions.

 

Keep in mind that Common Equity and Preferred Equity Partners are not carrying any debt in the deal.

 

So Where Am I In The Stack?

Many passive investors (Limited Partners, or LPs) fall into the Common Equity tier. Those with large amounts of capital to invest may gain access to the Preferred Equity tier if available.

 

Not all deals contain the same layers, so be sure to review the PPM and understand the structure of the stack. Building a relationship with the Sponsoring Team is also helpful so they understand your investment goals and interest in future opportunities as well!