Common equity is the riskiest and most rewarding component of the capital stack. It represents the ownership interest in a property and is subordinate to all other forms of financing, including senior debt, mezzanine debt, and preferred equity.
Characteristics of Common Equity:
- Position: Common equity holders are last in line for distributions and repayment but have the greatest potential for upside.
- Returns: Returns are not fixed and depend on the property’s performance. Investors benefit from appreciation, rental income, and profit after all obligations are met.
- Control: Common equity holders typically have voting rights and control over major decisions.
- Risk: Highest risk, as returns are only realized after all other claims are satisfied.
Advantages for Investors:
- Potential for High Returns: Greatest potential for significant returns through property appreciation and profit sharing.
- Ownership Control: Investors have a say in property management and strategic decisions.
Disadvantages:
- Highest Risk: Last in line for repayment, bearing the brunt of any losses.
- Variable Returns: Returns are uncertain and depend entirely on the property’s performance.
Example Scenario: For the $10 million property, after $7 million in senior debt, $2 million in mezzanine debt, and $1 million in preferred equity, any remaining funds and profits go to common equity holders. They have the most to gain if the property performs well but also the most to lose if it underperforms.
Conclusion: Common equity is a critical part of the capital stack, offering the highest potential returns but also the highest risk. Understanding its role is essential for investors looking to maximize their investment potential while being aware of the associated risks.
