What Is the Capital Stack in Real Estate?

An Institutional Framework for Understanding Risk and Return

Introduction

Real estate investing is ultimately a business of managing risk and return. At the core of this calculation is the capital stack—the structured layers of funding that make up a real estate deal. Understanding how each layer works is essential for any investor, developer, or lender navigating commercial real estate (CRE).

Whether you're deploying debt or equity, knowing where you sit in the capital stack determines your return expectations, risk exposure, and control in the project.

What Is the Capital Stack?

The capital stack refers to the hierarchy of capital sources used to finance a real estate investment. It outlines who gets paid first (and who bears the most risk) if the project underperforms or liquidates.

The typical capital stack consists of the following layers, from lowest risk to highest risk:

1. Senior Debt

  • Position: First lien on the asset

  • Risk/Return: Lowest risk, lowest return

  • Priority: Paid first from income or sale proceeds

  • Examples: Bank loans, insurance company loans, CMBS financing

2. Mezzanine Debt

  • Position: Subordinate to senior debt

  • Risk/Return: Higher risk, higher interest rates

  • Collateral: Often secured by equity pledge, not property

  • Used When: Sponsors want higher leverage beyond the senior loan

3. Preferred Equity

  • Position: Sits between debt and common equity

  • Returns: Fixed or preferred return + possible upside

  • Risk: Higher than debt, lower than common equity

  • Structure: Contractual priority over common equity in distributions

4. Common Equity

  • Position: Bottom of the stack

  • Returns: Residual upside (unlimited), but last to get paid

  • Risk: Highest risk, especially if project underperforms

  • Control: Usually holds decision-making power (GP or LP roles)

Visualizing the Capital Stack

▲ Risk │ │ Common Equity ← High return potential, last paid │ Preferred Equity │ Mezzanine Debt │ Senior Debt ← Lowest risk, first paid ▼ Priority of Payment

Why the Capital Stack Matters

Understanding the capital stack is essential for:

  • Investors: To evaluate risk-adjusted returns and capital protection

  • Sponsors/Developers: To structure financing with aligned incentives

  • Lenders: To assess how protected their position is

  • LPs & Family Offices: To underwrite investment opportunities and stress test downside risk

Each layer has a different risk-return profile, and savvy operators optimize the stack to balance leverage, flexibility, and cost of capital.

Institutional Insights: How Sterling Approaches the Stack

At Sterling Asset Group, structuring the capital stack isn’t just about funding a deal—it’s about aligning strategy with execution. We work with sponsors, investors, and lenders to:

  • Optimize capital costs while preserving flexibility

  • Structure mezzanine and preferred layers to reduce equity dilution

  • Ensure debt and equity partners are aligned in risk sharing

  • Advise on stack composition based on asset type, hold period, and exit strategy

Whether it's a stabilized multifamily refinance or a ground-up industrial development, the right capital stack can mean the difference between mediocrity and exceptional performance.

Conclusion

The capital stack is more than finance jargon—it's a framework that shapes risk, control, and return in every real estate investment. Institutional success starts with understanding where you sit in that stack—and how to structure it wisely.

For strategic guidance on structuring the capital stack in your next transaction, contact Sterling Asset Group.

Disclaimer

This content is for informational purposes only and does not constitute financial, legal, or investment advice. Real estate investing involves risk, and past performance is not indicative of future results. Please consult your professional advisor before making any investment decisions.