In order to maximize returns on your multifamily investment, it is important to have a well-structured capital stack. This means having the right mix of equity, debt, mezzanine financing, and preferred equity. A well-structured capital stack can provide a number of benefits, including lower interest rates, increased cash flow, and more flexible terms. Additionally, working with a professional capital stack advisor can help ensure that your capital stack is optimized for maximum returns.
The benefits of a well-structured capital stack
When it comes to real estate investing, one of the most important factors in achieving success is having a well-structured capital stack. A well-structured capital stack can provide many benefits, including:
Increased returns – By carefully structuring your capital stack, you can maximize your returns and minimize your risk.
Improved cash flow – A well-structured capital stack can improve your cash flow by providing more flexibility in how you use your funds.
Reduced costs – A well-structured capital stack can help you reduce your overall costs by taking advantage of lower interest rates and other financial incentives.
The basics of multifamily capital stacking
A typical multifamily capital stack consists of four main layers: equity, debt, mezzanine, and preferred equity. Each layer has its own set of benefits and drawbacks, so it’s important to understand how each one works before deciding how to structure your own capital stack.
The equity layer is the foundation of the capital stack and is typically made up of funds from investors or the property owner itself. Equity partners provide the bulk of the funding for a real estate project and typically receive higher returns than other types of investors. However, they also shoulder more risk than other investor types.
The debt layer is composed of loans from lending institutions such as banks or private lenders. Debt financing typically has lower interest rates than equity financing, but it also typically has stricter terms and conditions attached to it.
The mezzanine layer sits between the equity and debt layers and is typically made up of high-interest loans from private lenders. Mezzanine financing can be a good option for projects that don’t qualify for traditional bank financing but still need additional funding beyond what equity partners are willing to provide.
The preferred equity layer is similar to the mezzanine layer in that it sits between the equity and debt layers and is usually made up of high-interest loans from private lenders. However, preferred equity partners usually have priority over other investors if the project fails and goes into foreclosure.
How to structure your multifamily capital stack for maximum returns
The equity layer
The equity layer is the most important part of the capital stack, as it provides the bulk of the financing for a multifamily property. Equity investors typically include private individuals, institutional investors, and venture capitalists.
When structuring the equity layer of a multifamily capital stack, there are two main goals: to raise as much money as possible, and to minimize the amount of risk taken on by each individual investor.
One way to achieve these goals is to offer a variety of investment options, such as different types of equity securities (e.g., common stock, preferred stock, and convertible debentures) and different investment structures (e.g., joint ventures, limited partnerships, and syndications).
Another way to structure the equity layer for maximum returns is to use a “waterfall” approach, in which different investors receive different levels of return based on their position in the capital stack. For example, in a typical waterfall structure, early investors may receive a return of 20% while later investors may only receive a return of 10%. This allows for higher returns for those taking on more risk while still providing some level of return for all investors.
The debt layer
The debt layer of a multifamily capital stack typically consists of loans from banks or other financial institutions. Debt financing can be used to finance up to 80% of the purchase price of a property, making it an attractive option for those looking to minimize their upfront investment.
When structuring the debt layer of a multifamily capital stack, there are several things to consider: interest rates, loan terms, loan-to-value ratio (LTV), and debt service coverage ratio (DSCR). Interest rates will have a direct impact on your bottom line, so it’s important to shop around and compare offers from multiple lenders before selecting one.
Loan terms should also be considered carefully; shorter loans will have higher monthly payments but will save you money in interest over the life of the loan. The LTV is another important consideration; this is the percentage of the purchase price that will be financed by the loan and should be kept as low as possible to reduce risk.
Finally, the DSCR is used by lenders to assess whether or not a borrower can afford their loan payments; this ratio should be above 1.0 for most loans to be approved.
The mezzanine layer
The mezzanine layer is typically composed of high-yield debt or equity instruments that provide additional financing for a property beyond what can be obtained through traditional sources such as banks or insurance companies.
Mezzanine financing can be used to finance up to 100% of the purchase price of a property; however, because this type of financing is more expensive than traditional debt or equity options (due to its higher risks), it should generally only make up a small portion of the overall capital stack.
Some things to consider when structuring the mezzanine layer include: interest rates, repayment terms, warrants/options ,and covenants. Like with traditional debt financing, interest rates will have a direct impact on your bottom line so it’s important to compare offers from multiple lenders before selecting one.
Repayment terms should also be considered carefully; shorter loans will have higher monthly payments but will save you money in interest over time. Warrants and options give borrowers some upside potential if the property performs well, but they also increase downside risk; therefore, these should only be used if you are comfortable with taking on additional risk .
Finally, covenants are conditions that must be met in order for mezzanine financing to be approved; these can include things like minimum occupancy requirements or maximum leverage ratios .
The expertise and experience of a professional capital stack advisor
When it comes to something as important as your capital stack, you want to make sure you’re working with someone who knows what they’re doing. A professional capital stack advisor will have the expertise and experience necessary to help you put together a capital stack that maximizes your returns.
The peace of mind that comes with working with a professional capital stack advisor
In addition to the peace of mind that comes with knowing you’re working with an expert, a professional capital stack advisor can also take care of all the details for you. This can free up your time so that you can focus on other aspects of your investments.
A well-structured capital stack is essential for anyone looking to maximize their returns in the multifamily real estate market. By working with a professional capital stack advisor, you can ensure that your equity, debt, mezzanine, and preferred equity layers are all structured in a way that maximizes your return on investment.
Falcon Capital LLC is a private equity firm based in Washington, DC that offers investors the opportunity to achieve financial freedom through dependable passive income from commercial real-estate investments.