September 16, 2025
A plain-English guide to the most nuanced slices of the real estate capital stack
When you dip your toes into real estate investing, the alphabet soup of terms can be downright dizzying. Two that often trip up new investors are preferred equity vs mezzanine debt. These sit somewhere in the seemingly murky middle of the capital stack, a fancy term for the order in which people get paid.
If you're already feeling completely lost, that's normal. We'll walk through who gets paid when and the risks involved. After reading the following, you will come away with a clear grasp of how these terms impact your investing decisions.
What Is the Capital Stack?
To truly understand where preferred equity and mezzanine debt fit, it is helpful to examine the layers that surround them. Think of the capital stack like a ladder that shows who gets paid first and who takes on more risk when investing in a real estate project.
Remember, the higher up you are in the stack, the safer your investment, but your returns are usually smaller. The lower down you go, the riskier it gets, but if the project does well, the rewards can be tremendous.
Senior Debt
Senior debt is usually a loan from a bank, often called a first mortgage. It’s typically the safest position in the capital stack because it gets paid back before anyone else. Borrowers make regular payments of interest and principal to these lenders. In the event of default, senior debt holders have a first claim on the property or its proceeds, providing them with stronger protection than any other type of investor.
Mezzanine Debt or Second-Lien Loans
These are also loans, and they are next in line after senior debt. Since they're a bit riskier, investors often receive higher interest-based returns. However, remember that these investors don't own a piece of the project, so they don't have a say in how things operate.
Preferred Equity
At this stage of the stack, we’re talking about ownership. Preferred equity investors generally receive their payouts before anyone else in the equity group. Depending on the terms of the deal, they may also have limited decision-making rights. Unlike lenders, these investors hold an actual ownership interest in the project.
Common Equity
Common equity sits in the hot seat; the most risky spot in the stack, but it also comes with the most upside. These investors typically own a stake in the property and often have voting rights or a say in major decisions, depending on the deal's structure. While they are the last to get paid, if the project really takes off, they have the potential to earn significant profits.
What Is Preferred Equity?
Preferred equity bridges the gap between senior debt and common equity. It often comes with a fixed or targeted return, offering more predictability than common equity but less security than debt. Depending on how the deal is structured, preferred investors may also receive certain protections or limited rights that give them more influence than standard equity holders.
Related Article: Real Estate Syndication Explained for Everyday Investors
What Is Mezzanine Debt?
To recap, unlike equity, it’s structured as a loan, so investors typically receive steady interest-based returns, rather than profit shares.
If a borrower defaults, mezzanine lenders don’t have the same direct claim on the property that senior lenders do. Still, they usually have the right to take over the borrower’s ownership stake. That makes mezzanine debt riskier than senior debt but still more secure than preferred or common equity.
Related Article: Short-Term Investments: Put Your Money to Work Fast
Preferred Equity vs Mezzanine Debt
For everyday investors, the differences often come down to control, predictability, and accessibility.
Hard vs. Soft Preferred Equity
Hard preferred equity operates more like mezzanine debt: Returns are usually fixed, and investors may have stronger rights if the project stumbles.
The primary difference is that mezzanine debt holders remain lenders with contractual repayment priority, whereas hard preferred equity holders are technically investors, not creditors. This type of structure is more common in large institutional deals and typically requires steep minimum investments.
Conversely, soft preferred equity is tied more closely to project performance. That flexibility can mean higher returns in a strong market, but it also brings more risk if the property underperforms. So, unlike mezzanine debt, where payments are generally set and predictable, soft preferred equity payouts can fluctuate based on the deal's performance.
Due to this variability, soft preferred equity is usually best for experienced investors who are comfortable navigating market fluctuations.
Risk and Return
Preferred equity offers the chance for higher returns than mezzanine debt, but the tradeoff is greater risk. Since preferred equity sits behind lenders in the capital stack, it only pays out after debt holders have been satisfied.
Mezzanine debt, on the other hand, is a classic form of debt investing. Investors earn interest payments that are contractually owed, creating a steadier flow of income. You may not get the significant upside of equity, but you also don’t have to rely on property appreciation or sale timing to realize gains.
Accessibility
For many individual investors, accessibility is the deciding factor. Preferred equity deals are often reserved for institutions or high-net-worth individuals, with minimums of six figures that exclude most people.
On the other hand, mezzanine debt is being increasingly packaged in a way that allows everyday investors to access it, thanks to platforms that break projects into smaller investment shares. That means you can step into real estate debt investing with far lower minimums, allowing you to test the waters without tying up vast amounts of capital.
Choosing Your Lane
To recap, preferred equity is for the big players chasing higher upside with higher stakes. Mezzanine debt is the steadier path, with lower barriers and broader access for everyday investors. Remember, it is always best to do your own research and consult a financial advisor regarding concerns.
How Can You Start Your Investing Journey
If you’re curious about these parts of the capital stack, start by considering your own goals: Do you prefer steady, predictable income, or are you comfortable taking on more risk for the chance of higher returns? From there, think about your own goals: Do you want a steady, predictable income or are you comfortable taking on more risk for the chance at higher returns?
For many everyday and first-time investors, mezzanine debt offers a more accessible entry point. Because interest is earned on a set schedule, it provides a level of predictability you don’t always get with equity-based investments. And thanks to platforms like Groundfloor, you no longer need institutional connections or deep pockets to participate. With low minimums and transparent offerings, Groundfloor makes a mezzanine-style real estate investing approachable for both first-timers and seasoned investors.
