Understanding Capital Stacks in Commercial Real Estate
GP How-tos
A Quick Overview of a CRE Capital Stack
A capital stack is the arrangement of the financing used to fund a commercial real estate deal. That deal could be a building purchase, new construction, or even renovation. As a GP, you are already likely well familiar with the many different layers of and possibilities in a capital stack. But for clarity, let’s quickly summarize them. They can be concisely grouped into two categories with different subcategories based on the deal: equity and debt.
Equity
There are a few types of equity investments that go into commercial real estate deals. These resources often are used as the down payment on a property. Note that in a typical capital stack, equity investors are the last to be repaid in the event of a bankruptcy.
- Owner equity — Most commercial real estate firms will invest some of their own funds into a new deal.
- Preferred equity — Preferred equity is an investment that carries a fixed rate of return.
- Other equity — Capital received from other investors.
Debt
Debt is typically the leading source of funding in a commercial real estate transaction. There are a few different types of mortgages and loans that make up the difference between the purchase price and the down payment. In the event that the borrower goes bankrupt, the lenders behind these loans are the first to be repaid based on their position.
- First position mortgage — This mortgage will occupy as much as half to three-quarters of the total purchase amount after the down payment.
- Second position mortgage — A loan, whether a mortgage or a private loan, that is subordinate to the first position mortgage.
- Mezzanine loan — A mortgage that is subordinate to the first and second loans on the property.
How equity and debt work together in a capital stack can become complex quickly, particularly should the worst occur and the borrower defaults on the loan. But rather than focus on the negative possibilities and risks of a capital stack, let’s focus on what it takes to efficiently manage the many details and components of one. As you move forward with a new deal, there will be a fair amount of work needed to manage information, issue different types of payments, and ultimately observe the nuances of the deal structure.
Key Needs for Managing the Capital Stack in a Commercial Real Estate Deal
Investment Management
Ultimately, you’re going to need a solution for keeping all contacts, property details, documentation, and other information consolidated and centrally located. All of this information must be tied together intelligently so that you and your team can navigate managing fundraising, investor relations, transactions, and more as you carry out your daily responsibility of overseeing the property and its revenue generation.
Issuing Payments
Whether it’s repairs, maintenance, remodeling, legal support, accounting assistance, vendor payments, or any other need, you’re going to be handling numerous transactions as part of managing the property — both inbound and outbound. Doing this manually distracts your team from more important tasks and creates risk.
Automated Distributions
As time passes and the property begins to generate revenue, naturally you’ll start issuing returns to your investors (and while you’ll be obligated for making debt repayments according to the mortgage terms, remember that certain equity holders will get paid before others as well). While there is an administrative burden to this, quarterly distributions are further complicated by waterfall structures, if used. Ultimately, what matters here is getting the appropriate returns to the right people at the right time.
Document Management
Last but not least, the capital stack itself will have a significant amount of documentation that must be stored and made accessible (where appropriate) for your team, investors, and financial partners to access — to say nothing of the countless other aspects of the property that will generate a number of documents and files. Managing all of this can become overbearing, and the last thing you need is your team digging up old files when they should be focused on delivering value for investors, tenants, and your firm.
Simplify Managing the Capital Stack with Covercy
It’s clear that capital stacks in commercial real estate, while complex in themselves, also generate even more complexity after the funding has been secured. At Covercy, we’ve built the first real estate syndication platform where banking meets investment management. Our platform offers commercial real estate firms a single solution for managing:
