You can put money into a property in two basic ways: lend to the owner, or be an owner. Lenders are owed interest at an agreed rate and are paid before owners. Owners get whatever is left, which can be much more than they put in, or nothing.
Private real estate deals often use both. Knowing which one you hold, and what sits ahead of it, tells you a lot about your risk.
The capital stack
The capital stack is every source of money used to buy and improve a property, ranked by who gets paid first. From first to last:
Senior debt
A loan from a bank, agency lender, insurance company or debt fund, secured by a mortgage or deed of trust on the property. It is usually the largest and cheapest money in the deal, because it is first in line. The lender advances only part of the property’s value, so the layers below it act as a cushion.
Mezzanine debt
A second, smaller loan that sits behind the senior loan. It is usually secured by a pledge of the ownership interests in the company that owns the property, not by a mortgage on the building. Because it is repaid after the senior lender, it typically charges a higher rate. An intercreditor agreement with the senior lender usually limits what the mezzanine lender can do if things go wrong.
Preferred equity: a hybrid
Preferred equity is an ownership interest that behaves partly like a loan. The investor is typically paid at a stated rate and gets its capital back before common equity receives anything. Some deals also set a date by which it must be repaid.
But it is equity, not a loan. It has no lien on the property, its payments can depend on available cash, and its remedies, such as taking over management of the ownership company, come from the operating agreement rather than foreclosure. Terms vary widely.
Common equity
The sponsor’s and investors’ money that covers whatever the layers above do not. Common equity is paid last, takes the first loss and keeps whatever is left, shared between the sponsor and investors under the operating agreement. In many sponsor-led deals, passive investors hold this layer. See how real estate private equity works.
How each gets paid
Debt investors are owed interest at a rate set in the loan documents, fixed or tied to an index, usually paid monthly or quarterly. Principal typically comes back when the loan is repaid, often at a refinance or sale. The amount owed does not depend on how the property performs; collecting it depends on the borrower paying.
Equity investors may receive a share of what the property produces: cash flow after operating expenses, debt payments and reserves, plus proceeds from a refinance or sale after all debt is repaid. Those payments are not fixed. They can grow if the business plan works, and they can be reduced, paused or never made if it doesn’t.
Taxes differ too: interest is generally taxed as ordinary income, while equity investors in an LLC or partnership typically receive a Schedule K-1 that may pass through a share of depreciation, subject to limits. Ask your tax adviser.
Who absorbs losses first
Losses hit the bottom of the stack first: common equity, then preferred equity, then mezzanine debt, then senior debt.
Hypothetical example: a property is bought for $10 million with a $6 million senior loan, a $1 million mezzanine loan and $3 million of common equity. Its value then falls 20%, to $8 million, and it is sold. Figures are before costs.
| Position (paid in order) | Amount in | Recovered | Loss |
|---|---|---|---|
| Senior loan | $6M | $6M | None |
| Mezzanine loan | $1M | $1M | None |
| Common equity | $3M | $1M | $2M, about two-thirds |
| Whole property | $10M | $8M | $2M, or 20% |
A 20% drop in the property’s value became a loss of about two-thirds for common equity, while both lenders were repaid in full. A 30% drop, to $7 million, would erase the common equity entirely. At 40%, to $6 million, the mezzanine lender loses everything too, and the senior lender takes a loss once selling or foreclosure costs are counted.
Selling costs, unpaid interest and fees would make the equity loss larger; cash flow paid out during the hold would offset part of it. This shows mechanics only, not a prediction for any deal.
Upside: capped vs. uncapped
Leverage also works the other way. In the same hypothetical example, if the property sold for $12 million, the lenders would still receive only their principal plus agreed interest and fees. The remaining $5 million would go to common equity.
A lender’s upside is usually capped at agreed interest and fees, in exchange for being paid first. An equity investor’s upside has no fixed cap, in exchange for being paid last and taking losses first. Preferred equity usually sits in between: a stated rate and, in some deals, a share of profits.
Term and liquidity
Debt has a maturity date written into the loan. Bridge and construction loans tend to be short; permanent loans run longer. A loan may be repaid early, sometimes with a prepayment fee, or extended if the documents allow. It defaults if the borrower can’t repay at maturity.
Common equity usually has no maturity date. Investors get capital back, if at all, mainly when the sponsor refinances or sells, on a timeline the business plan estimates but does not promise. Interest rates, construction delays or the local market can push it back. See how real estate refinancing works.
Neither is easy to sell in a private deal. There is usually no market for a private loan participation or an LLC interest, and transfers often need the sponsor’s consent and must comply with securities laws. Expect to hold for the full term.
What “secured by the property” means
A loan secured by the property gives the lender a recorded lien on it, through a mortgage or deed of trust. If the borrower defaults, the lender can foreclose and be repaid from the property or its sale. That right, along with being paid first, is why senior debt costs less than equity. It does not remove the risk of loss.
- Foreclosure takes time. Depending on the state, and on whether the borrower contests it or files for bankruptcy, it can take months or even years. Payments usually stop in the meantime, and a distressed property may lose tenants or upkeep.
- Foreclosure costs money. Legal fees, property taxes, insurance, repairs and a broker’s commission come out of the recovery.
- Values can fall below the loan. If the property sells for less than the loan balance, the lender loses the difference unless it can collect from the borrower or a guarantor, which many commercial loans limit.
A lower loan-to-value (the loan balance divided by the property’s value) leaves the lender more room for these costs and declines, but does not eliminate them.
Thinking about fit
Neither is better in general; they suit different goals.
- Income: For payments at a stated rate and a set end date, debt or some preferred equity may fit better, with less upside. Payments can still stop.
- Growth: Common equity is where any value a sponsor creates through renovation, leasing and better operations lands. See how value-add real estate creates value.
- Time horizon: Private debt often has a shorter, fixed term. Equity often needs several years and can run longer than planned.
- Loss tolerance: Common equity can lose most or all of its value in a decline that leaves lenders whole, and lenders can lose money too. Size any investment to what you could afford to lose.
How this applies to MPIRE
MPIRE describes its plans as following a lifecycle: acquire, finance, improve or develop, stabilize, refinance or sell, and distribute. In such a plan, lenders are typically paid interest throughout, while any distributions to equity would come mainly from cash flow after stabilization and from refinance or sale proceeds.
- Positions offered to investors:
- Financing ahead of investors:
Each offering’s documents set out where investors sit in the stack. See how investing works.
Questions to ask
- Is this a loan, preferred equity or common equity, and which document says so?
- How much money sits ahead of my investment, and how much sits behind it?
- How am I paid, and can those payments be deferred or stopped?
- If it’s a loan, what secures it: a mortgage on the property or a pledge of ownership interests in the company that owns it?
- If the borrower defaults, what are my remedies, and who decides to use them?
- When is my capital due back, and what could delay it?
- For equity: when does the property’s debt mature, and what happens if it can’t be refinanced?
