These are arranged in the following order, and are divided into equity and debt (see Figure 1 below):Īll income and profits generated by the property will be outlined in the stack and, importantly, will show the order of distribution of such funds to each party providing the capital. Layers and priorities within a capital stackĪ capital stack typically comprises four layers or sections representing capital involved when an investor purchases and operates a commercial real estate investment. So, let’s have a closer look at how a capital stack works in terms of assessing investments, risks and rewards. The capital stack is amongst the most valuable techniques used in evaluating a potential investment in a commercial real estate deal, as it enables investors to know who gets paid/repaid, at what point in the investment cycle, and how much risk each party carries. It is one of the most important concepts for investors to use in evaluating risks associated with real estate and projected rates of return.īy having a complete understanding of a capital stack, investors can help protect their investments and achieve their desired gains by identifying areas of insufficient gains or, conversely, where the greatest risks lie. In short, a capital stack represents the underlying financial structure of a commercial real estate deal. The use of layers helps those parties involved in the transaction understand both the sources of capital, but also where priorities for repayment of debt and distribution of profits lie. but they are “stacked” in layers representing the different types of capital being employed in a deal. That is, not only are the various sources of capital identified and recorded. This mixture of capital (probably a mixture of equity and debt) in any real estate transaction is very important and is often known as a “capital stack”. Some of these layers of capital are known as “common equity” and “preferred equity” and “mezzanine” and “senior debt” and will be looked at more closely later. However, not all capital (equity and/or debt) is the same and capital can be broken down into several “layers” or “sub-divisons”, with different types of equity and debt available for use by investors. In reality, almost without exception, all major residential and commercial properties will be acquired using a combination of equity and debt. Will the purchase price be paid with capital provided by the buyer alone (“buyer’s equity” or just “equity”)? Or will the buyer borrow some of the money, seeking some form of loan or mortgage (“debt”) to fund part of the transaction-either as the buyer doesn’t have enough equity to purchase outright or, for a variety of other reasons, doesn’t wish to use all of his equity to fund the purchase? A price is agreed between buyer and seller, contracts arranged and the transaction proceeds.īut it’s important to consider the source of the money (“capital”) for the deal. In all real estate transactions, money changes hands. Like what you are reading? Subscribe and share with your network. This weekly newsletter is published by CPI Capital's CSO, COO, August Biniaz designed to update and educate you on all topics related to Real Estate Investing. Dear CPI Capital Real Estate Investment News Subscriber, Welcome back to This Week's Real Estate Private Equity Newsletter.
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