Equity, Debt & the Capital Stack

The capital stack is the layered set of money funding a project, from lowest risk/return at the bottom to highest at the top.

Layers (bottom to top)

1. Senior debt — the construction/permanent loan. First to be paid, lowest return, secured by the property.
2. Mezzanine debt / preferred equity — fills the gap between senior debt and common equity; higher cost.
3. Common equity — the developer and investors. Last to be paid, first to lose — but earns the upside.

Why it matters

• More debt (leverage) boosts returns but increases risk.
• Equity is the most expensive money but absorbs risk and earns the profit.
• Lenders cap leverage (via LTC/LTV and debt service coverage), so you must fill the rest with equity.

For a newer developer

Raising equity is often the hardest part. Common sources: your own cash, partners, friends-and-family, and eventually institutional equity once you have a track record — another reason a strong first project (or JV) matters.

Going Deeper (Intermediate)

The capital stack is the layered financing of a project, from lowest risk/return (senior debt) to highest (common equity): senior debt → mezzanine → preferred equity → common equity. Lower layers get paid back first; higher layers take more risk for more upside.

Advanced / Pro-Level

Where developers make outsized returns:

• Priority: debt is repaid before equity; risk and return rise up the stack.
• Sponsor (GP) equity vs. investor (LP) equity.
• The waterfall: return of capital → a preferred return (~6–8%) → splits with a promote/carried interest to the sponsor above hurdle rates.
• Leverage amplifies returns on equity (and risk) — within LTC/LTV limits.
• The developer often invests little cash yet earns the promote for sourcing, entitling, and executing the deal — that's the business model.

Practice Challenge

A deal returns 10% on total cost, but the sponsor's equity earns far more than 10%. How? (Answer: leverage + the promote — debt (paid a fixed ~6–7%) lets the equity capture the spread above its cost, amplifying equity returns; and the sponsor's promote/carried interest rewards them disproportionately above the LPs' preferred return for orchestrating the deal.)

In Practice

A developer over-leverages to boost returns, then a delay triggers default. More debt lifts returns and risk — balance the stack.

Common Mistakes to Avoid

• Over-leveraging the deal
• Underestimating how hard equity is to raise
• Misordering the capital stack

Takeaway: More leverage lifts returns and risk; a strong first project earns you cheaper equity.

Educational content — not legal, engineering, or financial advice. Requirements vary by jurisdiction; always confirm with the local authority and your professional team.