What is the capital stack and how does it work?

October 09, 2019

One small step for man, one giant leap for investors.

It takes a lot of research, determination and passion for an individual to take the leap and become a part of the investment industry. Especially if they want to be successful.

The belief that all you need to become an investor is a significant amount of funds is wrong. Although this obviously plays a vital part, it definitely isn´t the only thing a person needs. To be involved in the business, you should have a decent understanding of the real estate investment process and which parts you will be directly involved in. Getting a grasp of the capital stack is a great place to start.

The stack represents the different layers of financing sources that go into funding the purchase and improvement of a real estate project. This is one of the most valuable tools an investor has to estimate returns and compare them to potential risks, so it is crucial to have a good understanding.

Realistically, there is no limit to how many layers the capital stack can have, but the most simple analysis concentrates on the three most commonly used types of capital. The senior debt, the mezzanine debt and the equity capital.

The issuers of senior debt, which are often bondholders or banks, have their redemptions prioritised beacuse they usually supply around 60 per cent of the overall funding. This part of the stack is often secured by collateral, making it relatively less risky but with lower rewards.

Mezzanine debt is the middle layer which is made up of investors which supply the company with the residual amount of capital required to complete the project. In Accumulate Capital´s case, these investors get a second charge on the property. This safety net ensures they still reap the higher rewards but with added security.

Equity debt represents the money in which the developer and Accumulate Capital have put up themselves. There is ZERO security for our money, so we ensure only projects which will reach completion with a healthy enough profit are selected. Protecting ourselves and the investors.

When the property that has been invested in performs on par or better, the equity and mezzanine layers receive the highest returns. The bank or institutional lender makes the least but retained the most secure position throughout the hold.

It is important for investors to understand that in a well-constructed capital stack there isn´t a prime position to be in, there are just places that offer more or less risk, and in response pay out smaller or larger rewards.

High comprehension of the capital stack gives investors more details so that they can make a more informed decision.

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