When it comes to financing a property development project, understanding the capital stack is essential. Each layer of funding – from senior debt to mezzanine finance to equity -carries its own level of risk, return, and control. Whether you’re a developer or an investor, getting familiar with how these components work together can help you make more strategic financial decisions.
Key takeaway
- The capital stack outlines who funds a property development and in what repayment order.
- It typically includes four layers:
- Senior Debt (lowest risk, first repaid)
- Mezzanine Debt (fills the gap, higher returns and risk)
- Preferred Equity (hybrid layer with fixed returns)
- Common Equity (developer’s funds, highest risk and potential reward)
- The higher the layer, the greater the risk and expected return.
- Understanding this hierarchy helps developers optimise funding structure, manage risk, and attract investors.
What Is the Capital Stack in Property Development?
The capital stack is the hierarchy of funding sources used to finance a real estate development. It dictates who gets paid first and who takes on more risk in the event of underperformance or default.
In Australia, the typical development capital stack includes:
- Senior Debt (or First Mortgage Lending)
- Mezzanine Debt
- Preferred Equity
- Common Equity (Developer Equity)
Each layer comes with different rights, priorities, and expected returns.
1. Senior Debt: First in Line, Lowest Risk
Senior debt is usually provided by banks or non-bank lenders. It is secured by a first mortgage over the development site and has the lowest risk because it is repaid first before other forms of funding.
- Loan-to-value ratio (LVR) is typically capped around 60–65% for major banks and up to 70–75% for non-bank lenders.
- Cost: Lower interest rates than mezzanine or equity because of its senior position in the repayment order.
- Security: Includes a first-ranking charge over the project and personal/corporate guarantees.
Because of its conservative structure, senior debt often doesn’t provide sufficient funding for the full project cost, which is where mezzanine and equity layers come in.
2. Mezzanine Debt: Filling the Funding Gap
Mezzanine finance (or “mezz”) sits between senior debt and equity in the capital stack. It is usually secured by a second mortgage and is riskier than senior debt but less risky than equity, so it commands a higher return.
- Purpose: Bridges the shortfall between senior debt and developer equity.
- Security: May include second mortgage, share charges, and/or general security agreements (GSAs).
- Typical Loan-to-Cost (LTC): Can push total project funding up to 80–85% when combined with senior debt.
- Cost: Interest rates are significantly higher, often in the range of 15–22% per annum, depending on risk profile.
Mezzanine lenders are typically repaid only after senior debt is fully discharged, making this a riskier but more profitable funding layer.
3. Preferred Equity: A Hybrid Layer
Preferred equity is a hybrid form of capital that sits above common equity but below all forms of debt. It behaves like equity, but with agreed-upon fixed return expectations and sometimes priority distributions.
- Position in the stack: Ranks behind all debt but ahead of developer equity.
- Return: Typically fixed or structured (e.g. IRR-based), with no voting control in most cases.
- Use case: Often used when mezzanine debt is too expensive or unavailable, but the developer still wants to limit their own equity contribution.
This layer gives investors a more stable return than common equity but carries more risk than mezzanine.
4. Common Equity: Highest Risk, Highest Reward
Common equity, usually provided by the developer or project sponsor, is the most junior layer of the capital stack. It absorbs all remaining risk after debt and preferred equity are repaid.
- Return: Only paid after all other capital providers receive their returns.
- Control: Usually carries full control rights over the project.
- Risk: First to absorb losses; may lose all capital in a failed project.
Because of the high risk, common equity investors often expect higher returns, which can come in the form of project profit participation or capital gains upon project completion.
Visualising the Capital Stack
A typical Australian property development capital stack might look like this:
(10–15%)
(5–10%)
(10–20%)
(55–70%)
The actual mix depends on the project, lender appetite, and developer risk profile.
Why Understanding the Capital Stack Matters
Understanding the capital stack helps developers and investors make smarter decisions about:
- Funding mix: Identifying the right blend of debt and equity to optimise returns.
- Risk exposure: Knowing who is exposed to what level of risk at each layer.
- Negotiation: Structuring fair deals with investors and finance partners.
- Project feasibility: Ensuring all capital layers are aligned with project timelines and revenue expectations.
It’s also essential for presenting your deal to lenders, investors, or credit committees.
Final Thoughts: Choosing the Right Mix for Your Project
The capital stack is more than just a funding formula – it’s a reflection of your project’s financial strategy, risk profile, and value proposition. Getting the mix right can enhance your project’s profitability and resilience, especially in a complex market environment like 2025.
If you’re unsure how to structure your capital stack – or if you’re exploring alternative options like preferred equity or mezzanine finance – it’s worth consulting with experienced finance specialists.
Ready to Optimise Your Property Finance Strategy?
MFEG offers tailored funding solutions for property developers, including senior debt, mezzanine finance, and structured equity options. Explore our development finance options or get in touch with our team to discuss your next project.