The Capital Stack: Understanding Who Gets Paid First and Why It Matters

Before you commit capital to any real estate investment, you need to understand exactly where in the capital stack your investment sits. The capital stack is not an abstract concept. It is the legal document that determines in what order parties get paid when the asset generates income, and in what order they take losses when it does not.

The Basic Stack

A typical multifamily deal has a capital stack that looks like this from bottom (first to lose, last to be paid) to top (last to lose, first to be paid): GP equity, LP equity, preferred equity or mezzanine debt if present, and senior debt.

The senior lender gets paid first. Always. Debt service is the first expense after operating costs. What remains after debt service is available to equity. Within the equity position, the preferred return for LPs is paid before the GP earns any promote. GP equity is the last to be paid and the first to absorb losses.

What This Means for an LP

When you invest as a limited partner with a preferred return of 8%, you are entitled to 8% annualized on your committed capital before the GP earns any portion of the profits above that. This is the structural protection that makes LP investment sensible: you have a return hurdle that must be satisfied before your operator earns performance compensation.

The catch is that the preferred return is not guaranteed. It is a priority, not a promise. If the asset does not generate sufficient cash flow to pay the preferred return in a given quarter, that shortfall typically accrues and must be satisfied before any promote is paid. But if the asset performs poorly enough over the full hold period, the preferred return may not be fully satisfied.

The Promote Structure

The promote is the GP's share of profits above the preferred return hurdle. In a typical 70/30 structure with an 8% preferred return, LPs receive 100% of cash flow and profits until the 8% preferred is met, then 70% of everything above that. The GP receives 30% of everything above the preferred hurdle.

This structure aligns GP incentives with LP returns. If the deal underperforms, the GP earns less. If it outperforms, both parties benefit. The structure is only as strong as the GP's operational ability to hit the targets.

Questions to Ask Before Committing

Does the preferred return accrue if not paid in a given period? What is the waterfall on disposition proceeds? Is there a GP co-investment requirement? What fees does the GP collect regardless of performance, and how do those fees affect the LP return calculation? These questions should be answered before you review the deal metrics.