Reading the Capital Stack: Senior Debt, Mezzanine, and Preferred Equity

Every commercial real estate deal is financed by a stack of capital, ordered by risk. The layers at the bottom get paid first and demand the least return; the layers at the top get paid last and demand the most. Understanding the stack is the difference between a resilient structure and a fragile one.

Senior debt — the foundation

The senior loan sits at the bottom of the stack and is repaid first. Because it carries the least risk, it's the cheapest capital in the deal. It's also the most conservative: senior lenders cap leverage, require the strongest covenants, and hold the first lien on the property.

Mezzanine — the bridge in the middle

Mezzanine debt fills the gap between what the senior lender will fund and the equity a sponsor wants to put in. It's more expensive than senior debt and secured not by the property directly but by a pledge of the ownership interest. Mezzanine gets paid after the senior loan but before equity.

Preferred equity — priority ownership

Preferred equity sits above the debt but below common equity. It doesn't hold a lien; instead it takes a priority position in the equity waterfall — a preferred return paid before the common partners see a dollar. It's flexible capital that fills a gap without adding another layer of formal debt.

• Senior debt — lowest cost, lowest risk, first to be repaid
• Mezzanine — higher cost, secured by the ownership interest, repaid after senior
• Preferred equity — priority return above common equity, no lien
• Common equity — highest risk and highest potential return, last in line

A good structure isn't about maximizing leverage. It's about matching each layer of capital to the risk it's actually taking.

The art of capital markets advisory is assembling these layers so the total cost of capital is efficient and the structure holds up when the business plan meets reality. Get the stack right, and the deal has room to breathe.