In a real estate transaction, a capital stack refers to the different types of financing that are used to fund the purchase, development, or renovation of a property. The capital stack represents the different layers of financing that are stacked on top of each other, with each layer having a different priority in terms of repayment in the event of a default or foreclosure.
The capital stack typically includes different types of financing such as equity, mezzanine debt, senior debt, and preferred equity. Equity represents the ownership interest in the property, while debt represents borrowed money that must be repaid with interest.
Senior debt is typically the lowest-risk layer of the capital stack, as it has the first priority for repayment in the event of a default or foreclosure. Mezzanine debt is higher-risk and higher-return than senior debt, and is often used to fill the gap between the amount of senior debt available and the total financing needed for a project. Preferred equity is similar to mezzanine debt, but represents an ownership stake in the property rather than a debt obligation.
The capital stack is important in real estate transactions because it helps to determine the risk and return profile of the investment, as well as the order in which different investors or lenders will be paid back in the event of a default. Understanding the capital stack is essential for investors and lenders who are looking to participate in a real estate transaction, as it can affect the amount of risk they are exposed to and the potential returns they can earn.