How Are Real Estate Deals Financed? Funding Sources & the Capital Stack
How real estate is paid for — the right side of the balance sheet. Debt and equity across the four quadrants; residential vs. commercial lending; loan sizing through LTV, DSCR, and debt yield; the capital stack from senior debt to common equity; GP/LP structures, promotes, and distribution waterfalls; private funds; policy-driven capital like LIHTC and Opportunity Zones; public REITs, mortgage REITs, and CMBS; and the full waterfall from NOI to Cash Flow After Debt Service.
150 min
36
35
3
Learning Objectives
By the end of this chapter you should be able to:
- 1Explain real estate capital structures: how property value is financed through debt and equity, and why the mix of capital affects risk, return, control, and ownership economics.
- 2Evaluate commercial loan sizing: calculate and interpret LTV, DSCR, and Debt Yield, and identify which constraint determines the maximum loan amount.
- 3Analyze the capital stack: distinguish senior debt, mezzanine debt, preferred equity, and common equity, including payment priority, risk level, and expected returns.
- 4Explain GP/LP structures and waterfalls: describe how sponsors and investors share control, risk, fees, preferred returns, catch-ups, and promote economics in private real estate deals.
- 5Connect NOI to investor cash flow: build the waterfall from NOI → Cash Flow Before Debt Service → Cash Flow After Debt Service, and explain why financing and capital expenditures determine the actual cash return to equity investors.
Part One: The Right Side of the Balance Sheet. Section 1 of 36.
Part One · Every Real Estate Transaction Has a Balance Sheet
The Right Side of the Balance Sheet
Part One
Every Real Estate Transaction Has a Balance Sheet
Chapters 1 and 2 focused on the left side of the real estate balance sheet: the asset. You learned how to build Gross Potential Rent into Effective Gross Income, deduct operating expenses to arrive at Net Operating Income, and use that income stream to estimate property value. This chapter asks the next question: how is that property paid for? The answer is the right side of the balance sheet — debt and equity.
The Right Side of the Balance Sheet
Every real estate acquisition must be funded with some combination of borrowed capital and investor capital. The amount of debt, the amount of equity, the cost of each source of capital, and the rights attached to each layer all affect the investor's return, risk exposure, and control over the asset.
Two investors can buy the same property at the same price and earn very different returns based solely on how they finance the acquisition. One buyer may use mostly equity and accept lower leverage risk. Another may use more debt and increase potential returns, but also increase default risk, refinance risk, and sensitivity to changes in property value.
Core principle: Property Value = Debt + Equity. This is the capital stack in balance-sheet form. Every dollar of property value must be funded by some combination of lender capital and owner capital. The structure of that combination is one of the most important determinants of real estate investment returns.