SHA584: Financing Real Estate Investments

SC Johnson College of Business, Cornell University

Tool: Risk and Return for Capital Stack Components

The components of the capital stack have different risk and return characteristics as described in the table below.

Capital Stack Priority of

Risk Characteristics Expected Returns
Component Payment
Mortgage Debt First Priority Low. The ability to take Low. In exchange for the ability
possession of the real estate if to foreclose, mortgage interest
borrower defaults (foreclose) is 3% to 5% more than a
mitigates risk. country’s treasury bonds.
Mezzanine Second Priority Medium. The ability to take Medium. In exchange for the
Financing possession of the equity if the ability to take possession of the
borrower defaults mitigates risk. equity, mezzanine investors
expect returns in the range of
5% to 10% more than a
country’s treasury bonds.
Equity Financing Third Priority High. Equity must meet their High. In exchange for obtaining
obligations to other capital returns last, equity investors
providers or face loss of their generally expect returns that are
investment. 15% more than a country’s
treasury bonds.

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