Every real estate syndication has a capital stack. Most offering memoranda present it as a simple table: X percent senior debt, Y percent equity. That presentation is technically accurate and practically incomplete. The stack is where the economics of a deal live. It determines who gets paid first in a distribution, who takes the first loss in a downside scenario, and what your actual return looks like versus the advertised IRR.
This issue is a framework for reading any stack in under five minutes. After running through it on enough deals, the structure becomes pattern recognition.
The Framework
Step 1: Identify Every Layer and Its Priority
Capital stacks in commercial real estate typically contain some combination of four layers. The higher in the stack, the lower the risk and the lower the return. The lower in the stack (closer to the equity), the higher the risk and the higher the return expectations.
The percentages represent loan-to-cost (LTC). A deal capitalized at $25M total with $16.25M of senior debt, $3.75M of preferred equity, and $5M of common equity is a 65/15/20 stack. The first question is always: what percentage of the total deal cost sits above you in priority? That percentage is the cushion that must be eroded before you take a dollar of loss.
Step 2: Read the Debt Terms, Not Just the Rate
The senior debt rate matters, but the terms matter more. Three things to check:
- Recourse or non-recourse. Non-recourse debt limits LP liability to their invested equity. Recourse debt can expose the entity (and potentially sponsors with personal guarantees) beyond the asset value. Most LP structures use non-recourse senior debt with a sponsor personal guarantee for completion or bad-boy carveouts. Understand who is personally on the hook.
- Fixed or floating rate. A deal with floating rate bridge debt carries refinancing risk. Model the debt service at current rates and at 100 basis points higher. If the deal breaks at current rates without assuming improvement, the risk is already present, not theoretical.
- Loan maturity versus hold period. If the debt matures in 3 years and the projected hold is 5 years, there is a refinancing event mid-hold. Ask what conditions trigger a successful refinance and what happens if they are not met.
Step 3: Understand the Preferred Equity Mechanics
Preferred equity can mean materially different things depending on how it is structured. The minimum you need to know:
- Pref rate: Usually 6 to 9 percent annually on invested capital. Accruing or non-accruing. If accruing, unpaid pref compounds and must be satisfied before any common equity distributions.
- Cumulative or non-cumulative: Cumulative means unpaid pref carries forward. Non-cumulative means it does not. Cumulative preferred is the LP-protective version.
- Return-of-capital timing: In most structures, LPs receive return of capital before the sponsor participates in profits. Confirm this is explicitly stated in the waterfall, not assumed.
Where in the waterfall does the GP promote (carried interest) begin? Some structures calculate the promote after all LP capital is returned and after LP preferred return is satisfied. Others calculate it after preferred return only, before full return of capital. The difference in LP economics on a deal that underperforms is significant. Read the waterfall section of the PPM, not just the offering summary.
Step 4: Map the Waterfall
The waterfall is the sequence of distribution priorities. A standard LP-friendly waterfall looks like this:
A less LP-friendly structure may look identical in the offering summary but differ in Tier 2: the preferred return accrues only after return of capital, not on the invested balance. This delays when the pref clock starts and reduces total pref received if the hold is short or the asset is sold early.
The worked example below shows the difference on a $500,000 LP investment in a 5-year deal that exits at a 1.8x equity multiple.
Worked Example
Applying the Framework: A $22.5M Multifamily Acquisition
Deal: 96-unit multifamily asset. Acquisition price $22.5M. Total project cost with reserves and closing costs: $23.8M. Projected 5-year hold. Projected exit at $28.5M.
This is a modest but realistic return on a conservatively structured deal. The framework reveals where the returns come from, what layers exist above LP common equity, and what the effective cushion is against loss. If the asset sold for $21M instead of $28.5M, the preferred equity layer would absorb the shortfall first, and LP common equity would receive a reduced or partial return of capital. At $19M, LPs would receive less than their invested capital back.
Reading the capital stack before evaluating the pro forma ensures you understand the downside structure, not just the upside projection.