12.09.2025
Understand the capital stack
When you evaluate real estate development financing, you begin by analyzing the capital stack—the mix of debt and equity that funds a project. Understanding how each layer interacts helps you gauge risk, priority in cash flow and potential returns.
Capital stack components
The capital stack typically includes:
- Senior mortgage debt, often secured by a deed of trust and making up around 60% of total financing (Altus Group)
- Junior debt or mezzanine financing, positioned between senior debt and equity, with higher interest rates or preferred equity features
- Preferred equity, which may offer fixed dividends ahead of common equity
- Common equity, last in line for cash flow but offering the highest upside
Priority and returns
Senior debt holders have first claim on property cash flows and foreclosure rights, but limited upside. Mezzanine lenders negotiate intercreditor agreements to protect their position if senior lenders enforce. Equity investors share development profits after debt service, absorbing more risk in exchange for potential gains.
Evaluate debt and equity
Balancing debt and equity ensures project viability and protects your institution’s exposure.
Senior and mezzanine debt
Senior debt offers lower risk and interest rates, while mezzanine financing bridges funding gaps when senior lenders limit loan-to-value ratios. Mezzanine lenders expect higher returns but remain subordinate to senior lenders in a default scenario.
Preferred and common equity
Preferred equity investors receive priority dividends, making their position akin to hybrid debt. Common equity absorbs initial losses but benefits most from project appreciation once the property is leased or sold.
Assess loan structures
Choosing the right loan format aligns funding with construction and marketing timelines.
Interest capitalization
Development loans often allow interest to be capitalized during construction, adding accrued interest to the principal and deferring repayments until sales or leases commence (Altus Group). This structure reduces early cash demands but increases lender risk if market absorption stalls.
Construction-to-permanent loans
A construction-to-permanent loan combines funding for both the build phase and long-term mortgage, simplifying conversion at stabilization. For guidelines on structuring these loans, see our resource on construction loan for developers.
Acquisition and development loans
Acquisition and development (A&D) loans package land purchase and site improvement financing into one facility, covering tasks like grading, infrastructure and subdivision work (Nav). This comprehensive approach can streamline early-stage financing.
Prepare thorough documentation
Lenders require extensive evidence that a project will achieve its projected value and cash flows.
Feasibility and cash flow
Provide a detailed cash flow feasibility study, including pro forma income and expense schedules. Accurate cost estimates—such as material, labor and finish allowances—help validate assumptions. For multifamily projections, you may consider data from our cost to build multi-family analysis.
Equity and pre-sales
Document equity commitments and track record of capital contributions. Pre-sales or pre-leases of up to 60% of units can demonstrate market demand and reduce financing risk (Altus Group).
Manage project risks
Active risk management protects both lender and developer interests through construction and lease-up.
Construction cost inflation
Rising material prices and labor shortages continue to pressure budgets in 2025. Build in contingency buffers and monitor cost trends regularly to avoid overruns (Brady Martz).
Labor and regulatory changes
Skilled trades shortages and evolving zoning or environmental regulations can delay schedules and increase costs. Require developers to maintain recruitment plans and compliance reporting to mitigate these risks.
Collaborate with community banks
Partnering with local institutions can accelerate approvals and offer tailored solutions.
Local market expertise
Community banks, such as First County Bank, leverage deep regional knowledge of zoning, economic trends and property values to advise on lending decisions and underwriting assumptions (First County Bank).
Flexible financing options
These banks often provide lines of credit, bridge loans and specialized construction loans with more responsive underwriting, helping you close deals faster and adapt to project changes.
Monitor market conditions
Staying informed on macro trends enables proactive adjustments to underwriting criteria.
Interest rate trends
Higher financing costs following the low-rate era have raised development hurdles. Track central bank policy and swap curves to anticipate rate lock strategies.
Refinancing and liquidity pressures
With nearly $1.8 trillion in commercial loans maturing by 2026, refinancing risk is rising (Alliance CGC). Stress-test property cash flows under elevated rates and consider pre-refinance strategies.
Review key takeaways
- A clear understanding of the capital stack guides risk and return expectations.
- Align loan structures with construction timelines to minimize funding gaps.
- Comprehensive feasibility, equity and pre-sale documentation is non-negotiable.
- Active management of cost, labor and regulatory risks protects project viability.
- Collaborate with community banks and monitor interest and refinancing trends to adapt your underwriting approach.
Frequently asked questions
- What is the capital stack in real estate development financing?
The capital stack is the ordered mix of senior debt, junior debt, preferred equity and common equity that funds a project, with each layer having distinct risk-return profiles. - How much equity do lenders typically require?
Equity requirements vary by lender risk appetite, but loan-to-value ratios often limit debt to 60–70% of total project cost, necessitating 30–40% equity contributions. - What documentation is essential for pre-construction appraisal?
You need a detailed cash flow feasibility study, proof of equity commitments, pre-sale or pre-lease contracts, contingency plans and a development team resume. - How can community banks add value to luxury home projects?
Community banks offer local market insights, faster decision-making and customized financing products, which can enhance underwriter confidence and speed up closings. - Which loan structures best suit luxury home financing?
Construction-to-permanent loans streamline funding across build and permanent phases, while acquisition and development loans cover land acquisition and site work under a single facility.