Exit proceeds paid down a four-layer stack at each layer's claim on the exit date, and the cushion that accrued interest quietly removes.
Common equity loses first, and it starts losing sooner than its share of the stack suggests. Exit proceeds pay each layer's full claim in order of seniority, senior loan, mezzanine, preferred equity, and the common takes what is left. On an illustrative $100 million deal with 20 per cent common equity and a preferred layer accruing at 12 per cent, a sale at the purchase price after three years already costs the common 20.2 per cent of its money, and a 15.95 per cent fall wipes it out.
Worked in full in Private Equity Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Investors usually read a capital stack as percentages of the purchase price: 60 per cent senior, 10 mezzanine, 10 preferred, 20 common, so "the equity has a 20 per cent cushion". That reading uses original balances. At exit the claims ahead of the common include whatever has accrued, and the cushion has shrunk by that amount.
| Layer | Amount, $ | % of price | Terms |
|---|---|---|---|
| Senior loan | 60,000,000 | 60% | Interest-only, paid current |
| Mezzanine | 10,000,000 | 10% | 11.00%, paid current |
| Preferred equity | 10,000,000 | 10% | 12.00%, accrued and compounded |
| Common equity | 20,000,000 | 20% | Residual |
| Total | 100,000,000 | 100% |
The exit figures below are net sale proceeds at the end of year three, after selling costs. The senior and mezzanine interest has been paid out of operating cash flow along the way, so their claims at exit are their principal. The preferred equity has received nothing in cash and its return has rolled up. Any operating cash left after interest and paid to the common during the hold is outside these figures, which measure the return of capital at exit only.
Step 1. Each layer's claim at exit
Senior $60,000,000. Mezzanine $10,000,000. Preferred: $10,000,000 × 1.123 = $14,049,280, of which $4,049,280 is accrued return. In Excel: =10000000*(1+12%)^3.
Step 2. Attachment and detachment points
Stack the claims: senior from 0 to $60.00m, mezzanine to $70.00m, preferred to $84.05m. The common is paid only above $84.05m and gets its $20m back only at $104.05m.
Step 3. Pay the proceeds down the stack
Each layer receives MIN(proceeds left, its claim). In Excel, with proceeds in B1 and cumulative claims ahead of a layer in C2: =MAX(0,MIN(B1-C2,D2)), where D2 is the layer's own claim. The common takes MAX(0, proceeds − $84.05m).
At a flat exit of $100,000,000 the first three layers take $84,049,280 and the common receives $15,950,720: a loss of $4,049,280, or 20.2 per cent, on a property that held its value. The whole loss is the preferred equity's accrued return, which was paid for by the common.
| Net exit proceeds | Change in value | Senior | Mezzanine | Preferred | Common | Common recovery |
|---|---|---|---|---|---|---|
| 120.00 | 20.0% | 60.00 | 10.00 | 14.05 | 35.95 | 179.8% |
| 104.05 | 4.0% | 60.00 | 10.00 | 14.05 | 20.00 | 100.0% |
| 100.00 | 0.0% | 60.00 | 10.00 | 14.05 | 15.95 | 79.8% |
| 90.00 | −10.0% | 60.00 | 10.00 | 14.05 | 5.95 | 29.8% |
| 80.00 | −20.0% | 60.00 | 10.00 | 10.00 | 0.00 | 0.0% |
| 70.00 | −30.0% | 60.00 | 10.00 | 0.00 | 0.00 | 0.0% |
| 60.00 | −40.0% | 60.00 | 0.00 | 0.00 | 0.00 | 0.0% |
| 50.00 | −50.0% | 50.00 | 0.00 | 0.00 | 0.00 | 0.0% |
The order of loss is strict. A 10 per cent fall costs the common $14,049,280, 70.2 per cent of its money, while every layer above it is paid in full. At $80m the preferred recovers its original $10m but loses its accrued return, recovering 71.2 per cent of its claim. Mezzanine is untouched until the fall exceeds 30 per cent and is wiped out at 40. The senior lender loses only below $60m, when the property has lost 40 per cent of its value: at $50m it recovers 83.3 per cent.
Upside works the other way round. At $120m the common receives $35.95m, 1.80 times its money, while the preferred stays at $14.05m however high the price goes. That asymmetry is what the common is paid for, and why the preferred's coupon is lower than the common's target return.
Timing changes the answer as well. The longer the preferred equity accrues, the higher the common's attachment point climbs: a fourth or fifth year at 12 per cent compounding would push it further above the purchase price. A sponsor holding a deal for a recovery is therefore spending the common's cushion every year it waits, unless operating cash flow is used to pay the preferred return currently. That trade-off belongs in every hold-versus-sell discussion on a structured deal.
Measuring the equity cushion on original balances. On the purchase-price stack the common appears to absorb the first 20 per cent of any fall, from $100m down to $80m. On the claims at exit it absorbs only the first 15.95 per cent, and it needs a 4.0 per cent gain just to get its money back. The longer the hold and the higher the accruing coupon, the bigger the gap. The same logic applies to any PIK mezzanine, a capitalised interest reserve or a lender's exit fee: everything that rolls up ahead of the common moves its attachment point up. The lender's version of the same arithmetic, where accrued interest and sale costs shrink a mezzanine position's cushion, is in mezzanine attachment and detachment points. How much those layers cost the sponsor while the deal runs is a separate calculation, set out in the blended cost of a capital stack and mezzanine vs preferred equity.
Pay exit proceeds down the stack at each layer's claim on the exit date, not its original balance. Here the common equity is wiped out by a 15.95 per cent fall and loses 20.2 per cent of its money on a flat exit, because $4.05m of preferred return has accrued ahead of it. The free workbook for this case builds two capital stacks and shows what each layer recovers across a range of exit values.
The level of exit proceeds at which that layer starts to be paid. On the illustrative stack the mezzanine attaches at $60.00m and detaches at $70.00m, the preferred runs from $70.00m to $84.05m once its accrued return is included, and the common attaches at $84.05m. Below its attachment point a layer recovers nothing.
Yes. Preferred equity sits below mezzanine and is paid only after the mezzanine's claim is met in full. With $60m of senior and $10m of mezzanine ahead of it, the preferred is wiped out at $70m of proceeds, a 30 per cent fall, while the mezzanine loses nothing until the fall exceeds 30 per cent and everything at 40.
Because claims that accrued during the hold are paid first. A $10m preferred layer compounding at 12 per cent for three years is owed $14,049,280. At a $100m exit equal to the purchase price, the common receives $15,950,720 on $20m invested, a loss of 20.2 per cent, and needs a 4.0 per cent gain to break even.
This article is one calculation from Private Equity Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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