Mezzanine Finance vs Preferred Equity — Structuring the Optimal Development Capital Stack
Smart developers don't just raise debt — they construct a capital stack. A capital stack is the layered structure of funding sources in a property development, ranked from lowest risk (senior debt, cheapest) to highest risk (common equity, most expensive). Each layer serves a purpose: maximising leverage, optimising cost of capital, and accelerating return on equity.
Two of the most important — and most frequently confused — layers are mezzanine finance and preferred equity. Evcorp Commercial arranges both, structuring capital stacks from $10M to $500M+ for Australian developers.
The Capital Stack Explained
Every property development sits on a capital stack — a hierarchy of funding sources ranked by seniority:
- Senior Debt — First mortgage. Lowest risk, lowest cost (BBSY + 2.00%–3.75%). First claim on project proceeds. Typically 60–70% of total development cost.
- Mezzanine Debt — Second mortgage. Subordinated to senior, ranks ahead of equity. Higher cost (14–22% p.a.). Extends total leverage to 85–90% LTC.
- Preferred Equity — Equity-layer instrument. No mortgage — ranks behind all debt but ahead of common equity. Target IRR 14–22%. Extends total leverage to 90–92% LTC.
- Common Equity — Sponsor/developer equity. Last in line for proceeds, first to absorb losses. Highest risk, highest potential return.
The developer's objective is to construct a capital stack that maximises return on their common equity while keeping the project's blended cost of capital within feasible limits. This is the art of development finance.
Mezzanine Finance: The Second Mortgage
What It Is
Mezzanine finance is a loan secured by a second mortgage ranking behind the senior lender's first mortgage. In a default and enforcement scenario, the senior lender gets paid first; the mezzanine lender receives what remains. This subordination is why mezzanine costs more than senior debt.
When to Use Mezzanine
- The senior lender permits a second mortgage and the inter-creditor process is workable.
- You need additional leverage (beyond the senior LVR cap) but want a debt instrument with a defined maturity.
- The funding quantum is moderate — $2M to $50M per tranche.
- You want to retain all project equity upside. Mezzanine interest is fixed; there is typically no profit participation.
Mechanics
- Security: Second registered mortgage over the development property.
- Inter-creditor deed: Mandatory. Governs the relationship between senior and mezzanine lenders — priorities, cure rights, standstill periods, consent requirements.
- Pricing: 14–22% p.a., interest almost universally capitalised.
- Term: Aligned with the senior facility (typically 12–24 months).
- Combined leverage: Senior + mezzanine = 85–90% of total development cost.
Preferred Equity: The Equity-Layer Instrument
What It Is
Preferred equity is an equity investment — not a loan. The capital provider receives a preferred return (a priority share of project profits up to an agreed rate) plus, in many structures, a profit participation above that hurdle. Because it is equity rather than debt, preferred equity does not create a mortgage over the property and does not require an inter-creditor deed.
When to Use Preferred Equity
- The senior facility prohibits a second mortgage.
- You need maximum combined leverage — preferred equity can lift total funding to 90–92% LTC.
- You are running multiple projects and want to stretch your common equity across more deals.
- The capital provider wants an equity-like return profile with downside protection through the preferred return.
Mechanics
- Security: None — preferred equity is unsecured at the property level (though structural protections exist through the investment agreement).
- Inter-creditor: Not required — equity does not compete with mortgage security.
- Pricing: Target IRR 14–22%, structured as preferred return (accruing or current pay) plus, in some deals, profit participation above a hurdle rate.
- Term: Matched to the project lifecycle — typically exits on project completion and sale.
- Combined leverage: Senior + preferred equity = 90–92% of total development cost.
Head-to-Head Comparison
| Feature | Mezzanine Finance | Preferred Equity |
|---|---|---|
| Instrument type | Debt (second mortgage) | Equity (no mortgage) |
| Security | Second mortgage over property | Unsecured at property level |
| Inter-creditor deed | Required | Not required |
| Senior lender consent | Required — and can block | May not be required |
| Combined leverage | Up to 85–90% LTC | Up to 90–92% LTC |
| Cost | 14–22% p.a. (interest) | 14–22% target IRR |
| Profit participation | Rare — fixed interest | Common — above preferred return hurdle |
| Maturity | Fixed date — aligned with senior | Project lifecycle-linked |
| Typical quantum | $2M–$50M per tranche | $5M–$100M+ |
How Evcorp Commercial Structures Capital Stacks
Evcorp does not push one instrument over another. The starting point is always the project: its size, asset class, location, sponsor track record, and senior lender requirements. From there, Evcorp models the full capital stack — senior, mezzanine, preferred equity, and common equity — optimising for return on equity while keeping the blended cost of capital within feasible limits.
With access to 60+ lenders spanning the full capital stack — senior banks, non-bank stretch lenders, mezzanine funds, preferred equity providers, and family offices — Evcorp runs a genuinely whole-of-market process for every layer of the stack. The result is a capital structure that matches the deal, not the other way around.
Frequently Asked Questions
What is the difference between mezzanine finance and preferred equity?
Mezzanine finance is a second-ranking debt instrument — a loan secured by a second mortgage behind the senior lender. Preferred equity is an equity-layer instrument, not a loan — it provides capital in exchange for a preferred return but does not create a mortgage over the property. Key differences: (1) Security — mezzanine requires a second mortgage; preferred equity does not. (2) Inter-creditor — mezzanine requires an inter-creditor deed with the senior lender; preferred equity does not. (3) Leverage — preferred equity can typically achieve higher combined leverage (up to 90–92% LTC vs 85–90% for mezzanine). (4) Cost — mezzanine pricing is 14–22% p.a. as interest; preferred equity targets 14–22% IRR through preferred returns plus profit participation in some structures. (5) Senior lender — mezzanine requires senior lender consent; preferred equity may not.
When should a developer use mezzanine finance instead of preferred equity?
Use mezzanine when: (1) the senior lender permits a second mortgage and the inter-creditor process is manageable; (2) you need a defined, time-limited funding layer (mezzanine has a set maturity date); (3) you want to preserve more of the project's equity upside (mezzanine interest is fixed, preferred equity often includes profit participation); (4) the funding quantum is moderate ($2M–$20M). Use preferred equity when: (1) the senior facility prohibits a second mortgage; (2) you need maximum leverage (90–92% LTC); (3) you are running multiple projects and want to stretch your equity across more deals; (4) the capital provider is seeking an equity-like return profile.
What is a capital stack in property development?
A capital stack is the layered structure of funding sources in a property development, ranked by seniority and security. From top (lowest risk) to bottom (highest risk): Senior Debt (first mortgage, lowest cost) → Mezzanine Debt (second mortgage, higher cost) → Preferred Equity (equity layer, preferred return, no mortgage) → Common Equity (developer/sponsor equity, highest risk, highest return). Each layer serves a specific purpose in optimising the project's overall cost of capital and return on equity.
What does an inter-creditor deed do?
An inter-creditor deed is a legal agreement between the senior lender and the mezzanine lender that governs their respective rights, priorities, and remedies. It establishes: (1) the senior lender's priority over proceeds in a default scenario; (2) the mezzanine lender's rights to cure senior defaults (preventing the senior lender from enforcing prematurely); (3) information-sharing protocols between lenders; (4) standstill periods restricting the mezzanine lender's enforcement rights; (5) consent requirements for material changes to the senior facility. Evcorp negotiates inter-creditor deeds as part of the mezzanine mandate process.
How much does a layered capital stack cost?
A typical Australian development capital stack in 2026: Senior debt (65% LTC) at BBSY + 2.50%–3.75% = all-in cost ~7.00–8.25% p.a. Mezzanine (up to 85% LTC) at 16–20% p.a. on the mezzanine tranche only. Preferred equity (up to 92% LTC) at 16–22% target IRR. Blended all-in cost typically ranges from 8.50–12.00% p.a. depending on the mix. While mezzanine and preferred equity are more expensive than senior debt, they enable higher leverage and better return on sponsor equity — the true metric that matters to developers. Evcorp models the blended cost of capital for every capital stack structure.
Related Reading
- Mezzanine Finance — Evcorp's mezzanine finance broker landing page.
- Preferred Equity — Capital-stack optimisation and sponsor equity preservation.
- Mezzanine Finance for Property Developers — Plain-English guide with a worked example.
- Best Residential Development Finance Broker — Completing the residential capital stack.
Contact: info@evcorp.com.au | https://www.evcorp.com.au | Melbourne, Australia-wide