Every commercial real estate deal is paid for by a combination of borrowed money and invested money, and the way those pieces are layered has a name: the capital stack. It is one of the most useful concepts for a limited partner to understand, because where your dollars sit in the stack shapes both how you get paid and what happens if a deal underperforms. The stack is not jargon for its own sake — it is a map of priority.
What the capital stack is
Think of the capital stack as the full set of funding sources used to acquire and operate a property, arranged from lowest risk and first to be paid, at the bottom, to highest risk and last to be paid, at the top. Cash flow and sale proceeds generally flow up the stack: the bottom layers are satisfied first, and whatever remains moves to the layers above. Losses work in the opposite direction — they are absorbed from the top down.
That ordering, called priority or seniority, is the heart of the idea. Higher in the stack means more potential return in a good outcome, but also more exposure if things go wrong. Lower in the stack means more protection, but typically a more fixed, capped return.
The layers, from the bottom up
Senior debt. At the base sits the senior loan — usually the largest single piece, provided by a bank or other lender and secured by a mortgage on the property. It is paid first and carries the lowest risk, which is why it also earns the lowest return (an interest rate rather than a share of the upside). Because it is secured, the senior lender has the strongest claim on the asset if payments are not made.
Mezzanine debt. Above the senior loan, some deals include mezzanine financing — a second, subordinate layer of debt. It is paid after the senior loan but before equity, so it takes more risk and charges a higher rate. Not every deal has a mezzanine layer; it tends to appear in larger or more complex capitalizations.
Preferred equity. Moving into the equity layers, preferred equity sits below common equity in priority. Preferred investors typically receive a stated, priority return before common equity participates, in exchange for giving up some or all of the upside beyond that return. It behaves a little like a bridge between debt and common equity — more protected than common, less protected than debt.
Common equity. At the top of the stack is common equity — the most subordinate position. Common equity is paid last, after debt service and any preferred returns are satisfied. In exchange for taking that first-loss position, common equity generally captures the residual upside if the business plan succeeds. In many private real estate offerings, this is the layer that ordinary limited partners participate in, often alongside the sponsor.
Where an LP usually sits — and why it matters
As a limited partner, you are most often investing in the equity portion of the stack — frequently common equity, sometimes a preferred position, depending on how the offering is structured. Our guide to how passive CRE investing works walks through the LP model in more detail.
Understanding your position clarifies the bargain you are making. Equity is paid after the lenders, so it carries more risk than the debt in the same deal — but it is also the layer with a claim on appreciation and the property's improving income. Knowing whether you hold common or preferred equity, and what sits beneath you, tells you a great deal about the shape of your potential outcomes.
Leverage cuts both ways
Debt in the stack is also leverage, and leverage amplifies results in both directions. A modest amount of well-structured debt can improve equity returns when a property performs. The same debt can magnify losses when it does not, because the loan must be serviced regardless of how the property is doing, and the lender's claim comes first. This is why disciplined sponsors treat leverage as a tool to be used conservatively rather than maximized — the goal is durable income with a margin of safety, not the highest possible return assuming everything goes right.
The amount and terms of debt — how much, at what rate, fixed or floating, and when it matures — are central to a property's risk. A deal that looks attractive at a low interest rate can look very different if that rate resets higher or the loan comes due in a difficult market. We cover this and related exposures in understanding risk in commercial real estate.
How the stack shows up in underwriting
A careful underwriting and due-diligence process reads the capital stack closely, because the financing structure can make or break an otherwise sound property. Key questions include how much leverage is used relative to value and income, whether debt is fixed or floating, when loans mature relative to the business plan, and how preferred and common returns are ordered. You can see where this fits the broader process in CRE underwriting and due diligence.
The stack also interacts with strategy. A stabilized, net-leased asset can often support more debt comfortably than a value-add project with interrupted income, where conservative leverage leaves room for the plan to unfold. Matching the capital structure to the business plan — and to a sensible purchase basis — is part of underwriting downside-first.
A grounded way to think about it
The capital stack is ultimately a story about priority: who gets paid first, who absorbs losses first, and what each layer earns for the risk it takes. For a limited partner, the practical move is to know exactly where your dollars sit, how much debt sits beneath you, and how conservatively that debt is structured. None of this guarantees an outcome — real estate remains cyclical and exposed to forces no one controls — but understanding the stack turns an opaque deal into a readable one.
To go deeper, explore our private CRE insights, or see how to invest for the way we approach these decisions. Questions about a specific structure? Reach out — we're happy to talk it through.
