Cash flows. Repayments. Forecasts. Risks. These are all terms commercial real estate professionals need to know about (both individually and collectively). Combined, these elements of CRE are called “The Capital Stack.”
So, what is the capital stack?
Why does capital stack matter for CRE pros? What categories does it involve? How can commercial real estate software help? Let’s dive deeper into these questions and more.
What Is the Capital Stack?
There are two main components to the capital stack: equity and debt. These can be broken down into additional sub-categories (which we’ll discuss in the next section), but what you need to know is that the capital stack is important for understanding your commercial real estate cash flows, repayments and risks, as well as forecasting.
If your stack had a “top,” it would be equity, as it involves a higher level of investment risk (albeit with higher potential reward). Debt applies more to the bottom of the stack, as it’s more stable, predictable and serves as a foundation for your cash flow analysis.
Capital Stack Categories
Equity and debt are high-level categories of the capital stack, but they can be broken down further into four buckets/categories depending on your portfolio and cash flow needs. Here are the four main categories of the capital stack:
- Common equity: Periodic payments with high returns related to asset performance. As CRE news website Jasper notes, “Return on common equity is directly tied to the performance of the asset. Being the primary benefactor of asset appreciation, investors in this layer have the potential to generate very high returns.”
- Preferred equity: This list is ordered in a specific way to help you visualize how the different categories stack up against each other (no pun intended). In between Senior debt and common equity, preferred equity involves safer, typically higher returns than common equity and is paid first due to a “hurdle rate.”
- Mezzanine debt: A unique form of debt with unpredictable interest rates, mezzanine debt is paid after senior debt. It’s a hybrid investment form that varies depending on the unique nature of the individual investment.
- Senior debt: As CRE company Feldman Equities notes, “senior debt, at the bottom of the capital stack, holds the strongest priority, meaning senior debt lenders are the first to be paid.” It’s protected against underpayments, foreclosures, liquidations and more.
The Capital Stack & CRE Software
As stated in the introduction, the capital stack involves several important elements in the cash flow, from repayments and risks to forecasting. It’s important for commercial real estate professionals to know where their investment falls in the stack so they can forecast risks and rewards—and ultimately build their portfolio in a smarter, more organized way. Quarem makes tracking data like this seamless and allows you to build robust, actionable reports and forecasting related to your capital stack.
If you have any questions or would like to see Quarem in action, request a demo today!