In order of priority from lowest risk to highest risk in typical real estate financing, which sequence is correct?

In order of priority from lowest risk to highest risk in typical real estate financing, which sequence is correct?

• A. Senior debt, mezzanine debt, preferred equity, common equity
• B. Common equity, preferred equity, mezzanine debt, senior debt
• C. Mezzanine debt, senior debt, common equity, preferred equity
• D. Senior debt, common equity, mezzanine debt, preferred equity

Answer: (A)

Priority of claims in the capital stack drives risk in real estate financing. The party at the top has the first claim on cash flow and sale proceeds, so their investment carries the smallest loss risk and typically requires a lower return. Senior debt is at the top, usually secured by the property and the first lien on cash flows, so it gets paid first if things go sour, making it the lowest risk. Mezzanine debt sits below senior debt. It is subordinate to the senior lender, so it would be paid only after the senior debt is satisfied. It often carries higher interest and may include equity-like features, reflecting higher risk and higher potential return than senior debt. Below that is preferred equity. It has priority over common equity for distributions and proceeds after debt, but it remains subordinate to all debt. Its return is often fixed, but it lacks the security of debt, so it’s riskier than both debt layers. At the bottom is common equity, the residual layer. Common shareholders receive distributions only after all debt and preferred claims are satisfied, which means the highest risk but also the greatest upside if the project performs well. So the sequence from lowest to highest risk is senior debt, mezzanine debt, preferred equity, common equity.

Priority of claims in the capital stack drives risk in real estate financing. The party at the top has the first claim on cash flow and sale proceeds, so their investment carries the smallest loss risk and typically requires a lower return. Senior debt is at the top, usually secured by the property and the first lien on cash flows, so it gets paid first if things go sour, making it the lowest risk.

Mezzanine debt sits below senior debt. It is subordinate to the senior lender, so it would be paid only after the senior debt is satisfied. It often carries higher interest and may include equity-like features, reflecting higher risk and higher potential return than senior debt.

Below that is preferred equity. It has priority over common equity for distributions and proceeds after debt, but it remains subordinate to all debt. Its return is often fixed, but it lacks the security of debt, so it’s riskier than both debt layers.

At the bottom is common equity, the residual layer. Common shareholders receive distributions only after all debt and preferred claims are satisfied, which means the highest risk but also the greatest upside if the project performs well.

So the sequence from lowest to highest risk is senior debt, mezzanine debt, preferred equity, common equity.