The Capital Stack: CMBS and Preferred Equity

The capital stack in commercial real estate (CRE) refers to the hierarchy of financing sources used to fund a property acquisition or development. Every dollar in a commercial real estate transaction comes from somewhere — a bank, a government program, an institutional investor, or the owner's own pocket — and each source occupies a specific position in that stack, with a defined priority of repayment and a corresponding level of risk and return.

Understanding where CMBS debt and preferred equity sit in that stack is not just academic. It directly determines your cost of capital, how much you need to bring to closing, and how much risk you are taking on relative to your projected returns. Get the stack wrong and you leave money on the table — or worse, you over-leverage and create a loan that doesn't service.

The Four Layers of the Capital Stack

A complete commercial real estate capital stack has four potential layers, listed from lowest risk / lowest return (top of the stack) to highest risk / highest return (bottom):

1. Senior Debt (First Mortgage) — This is the largest piece of most transactions, typically 55% to 75% of the total capital. Senior debt is secured by a first lien on the property. It is the first to be repaid from operating cash flow and the first to be repaid in a liquidation event. Because the risk is lowest, the interest rate is lowest. CMBS conduit loans, bank loans, agency (Fannie/Freddie) loans, and SBA 504 first mortgages all sit in this position.

2. Mezzanine Debt — Mezzanine debt is secured not by the property itself but by a pledge of the ownership interest (equity) in the entity that owns the property. It ranks junior to senior debt, meaning mezzanine lenders are repaid after the first mortgage is satisfied. Mezzanine rates are higher than senior debt — typically 300 to 600 basis points more — to compensate for the elevated risk. Not all transactions include a mezzanine layer; CMBS loans in particular often prohibit mezzanine debt without servicer consent.

3. Preferred Equity — Preferred equity sits between mezzanine debt and common equity in the repayment hierarchy. Unlike debt, preferred equity is a true ownership interest, but it carries a preferred return — meaning preferred equity investors receive their negotiated return before common equity receives any distributions. In a distressed scenario, preferred equity holders have less protection than mezzanine lenders because they cannot foreclose on the property in the traditional sense.

4. Common Equity — Common equity is the owner's direct investment in the property. It is the last to be repaid and the first to absorb losses. The return potential is highest, but so is the risk. Most lenders require a minimum common equity contribution — typically 25% to 35% of total project cost — to ensure the borrower has meaningful "skin in the game."

What Is CMBS Debt and Why Does It Lead the Stack?

Commercial Mortgage-Backed Securities (CMBS) loans are fixed-rate, non-recourse first mortgages originated by conduit lenders, pooled together with other commercial mortgages, and sold to investors as rated bonds. Because they are securitized and held by multiple investors (not a single bank), CMBS loans are governed by strict servicing rules and cannot be easily modified after closing.

CMBS loans sit at the senior debt position — the lowest-risk, first-to-be-repaid layer of the stack. This priority position, combined with the non-recourse structure (the lender's only recourse upon default is the property itself), makes CMBS attractive to borrowers who want to limit personal liability. CMBS loans are well-suited for stabilized, income-producing properties such as hotels, multifamily, office, industrial, and self-storage assets with at least 12 months of operating history.

Typical CMBS loan parameters: 10-year fixed term, 25–30 year amortization, LTV up to 75%, DSCR minimum of 1.25x, non-recourse with standard carve-outs.

Where Does Preferred Equity Fit?

Preferred equity sits between senior debt and common equity. It provides capital partners a higher yield than senior debt (typically 8% to 14% preferred return) while giving borrowers more leverage than common equity alone allows. Preferred equity holders receive their negotiated return before common equity holders receive any distributions, but they are subordinate to all debt — meaning the senior lender is fully repaid before preferred equity sees a dollar in a liquidation.

Preferred equity is most commonly used in two scenarios: (1) to bridge the gap between the senior loan proceeds and the total capital needed when a project is too large for a single lender, and (2) to allow an owner to pull equity out of an appreciated property without refinancing the existing senior debt.

How Stacking CMBS with Preferred Equity Reduces Your Cost of Capital

The key insight is that CMBS debt — because it is the safest layer — carries the lowest interest rate, often 150 to 300 basis points below what mezzanine or preferred equity investors require. By maximizing the CMBS first mortgage (up to the lender's LTV and DSCR constraints) and using preferred equity to fill additional capital needs, a borrower can often achieve a lower weighted average cost of capital than relying on common equity alone.

Example: A hotel acquisition with a total cost of $20 million might be structured as $13 million CMBS first mortgage (65% LTV at 6.5%), $3 million preferred equity (15% at 10%), and $4 million common equity (20%). The blended cost across debt and preferred equity is significantly lower than financing the entire $16 million with common equity or high-cost mezzanine debt.

Frequently Asked Questions

Contact the First Realty Capital team to model the optimal capital stack for your next commercial real estate transaction. We specialize in sourcing CMBS first mortgages and identifying preferred equity partners to complete your capital structure.

Related reading: What Is a Conduit Loan?  |  Fixed vs. Variable Commercial Mortgage Rates