Forbes: Optimizing The Capital Stack In Today’s Market

Once you’ve found a great real estate investment opportunity, it will be time to raise capital for the transaction. This step typically involves structuring the layers of equity and debt. In simple terms, equity refers to money that you’ll bring to the table and debt includes the different types of financing you’ll secure for the deal. You’ll likely be working with a partner for this step, along with other investors and lenders.

For simplicity purposes, in this article we’ll look at two types of equity: common equity and preferred equity. In a future article, we’ll consider two forms of debt: senior debt and mezzanine debt. We’ll cover the risks and rewards that each layer brings, along with the players involved and factors impacting today’s market.

Common Equity in a Real Estate Investment

In a transaction, the common equity portion reflects basic ownership, and typically includes the individuals in the deal who have “skin in the game.” This could be you, your partner, and other investors on your team. Common equity could come from personal savings or a lump sum of income (such as a bonus or inheritance) that you receive and want to invest.

There is often a general partner, or sponsor, who runs the day-to-day activities of the deal and raises money from limited partners. The sponsor may contribute anywhere from 5% to 50% of the common equity, depending on the size of the transaction. If you’re the general partner and are putting in your own funds, it can resonate well with your investors and show that you have confidence in a deal.

Those who contribute common equity carry the highest amount of risk, as they hold the lowest priority in the capital stack. They’ll be paid last, after lenders receive their funds and those with preferred equity have been given their share. On the upside, those who contribute common equity have the greatest potential for reward too.