A well-engineered real estate capital stack is one of the most powerful levers that commercial real estate (CRE) firms have to protect cashflow, reduce risk, and compound equity over time. Yet in practice, many stacks evolve reactively—piecemeal raises, extensions, and quick fixes layered on top of each other—until the cost of capital creeps up and flexibility disappears. This article lays out a technical, action-oriented approach to optimizing your stack at the asset– and portfolio-level, with practical strategies you can deploy now.
What “Optimization” Really Means
Think of optimization as solving for the best mix of cost, control, and optionality under your unique constraints (business plan, lender appetite, and covenants). Concretely, the target is to minimize weighted average cost of capital (WACC) while maintaining:
- Sufficient cushion on debt metrics across rate and net operating income (NOI) scenarios, such as debt service coverage ratio (DSCR), debt yield, and loan-to-value (LTV)
- Adequate liquidity for CapEx, leasing, and reserves
- Clean exit paths (prepay, release, or recap) that preserve equity and promote economics, while aligning with business plans.
As a quick refresher, your capital stack is typically comprised of:
- Senior debt (lowest cost of capital; highest control by lender; most covenants)
- Mezzanine debt (higher cost; intercreditor governs remedies)
- Preferred equity (cash/payment-in-kind preferred return; negotiated controls)
- Common equity (residual return; promotes and waterfalls drive sponsor upside)
Quantify First: Build the Efficient Frontier for Your Deal
Before you restructure, quantify the trade-offs:
- WACC
Suppose your stack is heavy on mezzanine and preferred equity, producing a blended cost of around 10%. If you replace some of those expensive layers with slightly pricier senior debt, the overall cost can still fall. Always compare the trade-off between layers, not just the coupon on one piece. - Resiliency Metrics
Model DSCR (NOI / debt service), Debt Yield (stabilized NOI / loan amount), and LTV under multiple scenarios: base case, downside case (−5% to −15% NOI), and interest rate stress cases applied to both. Target DSCR ≥ 1.25x and Debt Yield ≥ 9%–10% (asset- and lender-dependent) through the cycle. - Liquidity Profile
Understand cash needs for tenant improvements / leasing commissions, CapEx, rate-cap renewals, and seasonal NOI. A stack with razor-thin cash sweeps or restricted accounts can create liquidity stress even if WACC looks good. - Exit Friction
Prepayment structures, partial releases, and intercreditor restrictions affect how “trapped” you are. Quantify the net present value (NPV) impact, including swap breakage, under likely exit scenarios—sometimes a slightly higher rate is worth much lower exit friction.
Strategy 1: Term and Rate Structure that Matches the Business Plan
Align the term of your financing with your value-creation timeline:
- Stabilization plays: Float-to-fixed or bridge-to-perm pathways, with a forward-starting cap or swap that locks your take-out affordability before NOI fully seasons.
- Core holds: Fixed rate with open prepay windows late in term or 5-4-3-2-1 stepdowns to keep optionality if cap rates compress.
- Capex-heavy deals: Delayed-draw term loans or revolvers to fund projects on schedule without over-raising equity.
For floating-rate debt, design your hedge (cap, collar, or swap) to the actual exposure, not just lender minimums. Align cap maturities to your likely extension periods so you don’t face a forced, expensive cap purchase at the worst moment.
Strategy 2: Replace Expensive Layers—Lower WACC Without Sacrificing Safety
A common win is to trade smaller, very expensive slices (mezzanine/preferred) for a slightly higher-coupon but deeper senior loan—net WACC still falls, and DSCR often improves.
In one $100M example, a stack heavy with mezzanine and preferred had a cost north of 10% and a DSCR near 1.10x. Swapping those layers for more senior debt brought the cost down and pushed DSCR into the 1.20x range—proof that a higher senior coupon can still mean a cheaper, safer stack overall.
Execution paths:
- Re-underwrite to “business-plan NOI.” Show lender locked-in rent growth or executed leases to justify deeper senior proceeds.
- Portfolio cross-collateralization. Blend a weaker asset with a stronger one to raise senior proceeds and strip out mezzanine/preferred at the deal level.
- Holdco NAV lines. Replace deal-level mezzanine with a diversified, covenant-lite holdco facility secured by equity interests.
Strategy 3: Engineer Covenants and Cash Management to Fit the Deal—Not Fight It
The cheapest coupon in the world isn’t “cheap” if cash gets trapped or triggers block your plan.
- DSCR vs. Debt Yield: For transitional assets with floating rate debt, Debt Yield is often the better anchor; it’s NOI-based and less sensitive to temporary interest spikes.
- Cash sweeps: Negotiate springing, not hard sweeps, tied to metrics with clear cure rights (e.g., reserve deposits, tenant improvements / leasing commissions milestones).
- Reserves: Correctly size CapEx, tenant improvements / leasing commissions, and replacement/repair fund reserve releases to your leasing cadence to avoid liquidity squeezes mid-project.
- Intercreditor: Preserve cure and standstill rights for mezzanine/preferred so a transient hiccup doesn’t hand control to a junior party.
Strategy 4: Hedge Designed to Defend Your Downside Without Overpaying
- Cap vs. swap: Caps preserve upside and flexibility by limiting rate spikes; swaps fix the coupon, removing volatility but reducing prepay optionality (and adding breakage risk).
- Forward-starting instruments: Use forward caps/swaps to lock affordability for extensions or a known bridge-to-perm take-out.
- Budget for cap replacements: If your likely hold exceeds the first cap term, reserve for a cap renewal so you’re not a forced buyer later.
A well-structured hedge can move a stressed DSCR from marginal to solid—often for a relatively modest premium. The goal isn’t just rate protection; it’s locking in the breathing room your business plan needs when rates move against you.
Strategy 5: Optimize at the Portfolio Level, Not Just Asset by Asset
Sponsors often accept suboptimal debt on one asset because they’re looking at it in isolation. Keep in mind that the following strategies may not be suitable for all borrowers and rely on specific ownership and entity structuring.
- Rebalance leverage across assets to equalize debt yield and DSCR cushions where future NOI is more/less certain.
- Cash pooling and internal “capco” lending to reduce external mezzanine/preferred.
- Release spreads negotiated up front enable selective dispositions without paying whole-loan make-whole penalties.
The optimization target is a portfolio-level efficient frontier—lower WACC with higher resilience—not maximizing proceeds on every single asset.
A Practical, Repeatable Optimization Process
- Debt inventory and normalization
Centralize loan docs, covenants, prepay terms, reset dates, and hedge details. Normalize to a common analytics model. - Scenario modeling
Underwrite base/downside NOI, forward rates, CapEx, and leasing timelines. Produce DSCR/DY/LTV projections, cashflow, and WACC under each scenario. - Capital actions
Prioritize actions by bps saved per unit of complexity: (a) refinance or restructure to replace expensive layers, (b) covenant/cash-management fixes, (c) hedge upgrades, (d) portfolio cross-collateralization or net asset value (NAV) line. - Decision thresholds
Green-light when the action yields ≥50–150 bps WACC improvement, ≥10–25 bps DSCR cushion in downside, or materially lower prepay friction—and can be executed inside your governance and timeline constraints. - Governance and communication
Align sponsors, LPs, and lenders on data, assumptions, and success metrics before engaging term sheets. The fastest path to “yes” is a transparent underwriting package that anticipates credit questions.
Bringing it All Together
Real optimization is not a slogan—it’s a disciplined combination of math, structure, and strategy. The key principles are straightforward: reduce expensive capital slices, align covenants and cash controls with your business plan, manage rate risk deliberately, and design exits with minimal friction. The goal is not maximum leverage on each asset, but the lowest sustainable cost of capital and the highest resilience across the portfolio.
Share your current debt schedule with us, and we’ll show where you can lower your cost of capital, improve risk cushions, and execute efficiently.
