The capital stack, explained

The capital stack is the order in which different pools of money get paid back from an asset's cash flow. The lowest layer gets paid first and earns the lowest return; the highest layer gets paid last and earns the highest.

Senior debt sits at the bottom. It is the cheapest capital in the stack, typically priced at around 5–7%, and usually funds 50–65% of total cost. A senior lender holds a first charge over the asset, which is why their return can be that low — if anything goes wrong, they are first in line.

Mezzanine sits above senior. It is more expensive, around 10–15%, and fills the gap from around 65% up to roughly 75–85% of cost. It is debt-like but subordinated, often with a second-ranking charge or a share pledge as security.

Preferred equity sits above mezz. It looks like debt in that it earns a fixed coupon and is paid before the common, but it is structured as equity and ranks behind all lenders in a liquidation.

Common equity sits at the top. It takes the first loss if anything goes wrong, and in return captures all the upside above every other layer. It is the most expensive capital in the stack and the most patient.

The skill in structuring a deal is assembling the cheapest stack the asset's cash flow can safely support. Pile too much senior debt on and you breach DSCR covenants in the first downturn. Use too much equity and your returns to the common collapse. The right stack is the one where each layer is sized exactly to what the asset can comfortably service.