CRE Financing: What are the typical components of a capital structure?

In commercial real estate, the typical levels in a capital structure include senior debt, mezzanine financing, and equity financing.

Senior Debt

Senior debt is the primary form of financing in commercial real estate and is typically provided by banks or other financial institutions. This type of financing is secured by a first mortgage on the property and is considered senior because it has priority over other types of financing in the event of a default. Senior debt is typically used to finance the majority of a commercial real estate project and has the lowest cost of capital.

Mezzanine Financing

Mezzanine financing is a type of financing that sits between senior debt and equity financing in the capital structure. Mezzanine financing is typically provided by specialized lenders or private equity firms and is unsecured, which means it is not backed by a specific asset. Mezzanine financing is considered riskier than senior debt, and therefore carries a higher cost of capital. However, it is less expensive than equity financing and can be an attractive option for borrowers who need additional capital to complete a project.

Equity Financing

Equity financing is a form of financing that involves raising capital from investors in exchange for ownership in the property. Equity financing is typically used to finance a smaller portion of a commercial real estate project and has the highest cost of capital. Equity investors share in the property’s income and appreciation and may have a say in major decisions related to the property.

Overall, the capital structure in commercial real estate is designed to balance risk and reward for both borrowers and lenders. Senior debt provides the lowest cost of capital but also carries the lowest risk, while mezzanine financing and equity financing provide higher costs of capital but also carry higher risks. By carefully balancing the various forms of financing in the capital structure, borrowers can access the capital they need to complete a commercial real estate project while managing their risk and minimizing their costs.