Capital Stacks for Small Houston Builders

A capital stack is just a story about who gets paid first. Most small Houston builders learn this the hard way, by trying to fund a project with one source of capital and finding out at closing that the source does not cover the whole job. The fix is to layer. Senior debt, gap, and equity. Each layer with clear terms and a clear position. Tell the story clearly and the money shows up.

What a Capital Stack Is

A capital stack is the combination of all the funding sources for a single project, ordered by payback priority. The most senior position gets paid first if anything goes wrong. The most junior position gets paid last and carries the most risk. Returns generally rise as you move down the stack because risk rises with junior position.

The Layers

Senior Debt

The largest piece, usually 65 to 80 percent of project cost. For most small Houston builders, this is hard money or a construction loan from a bank. Secured by a first lien on the property. Lowest cost of capital in the stack, but with the most rigid underwriting.

Mezzanine or Gap Debt

A second-position loan that fills the gap between senior debt and your equity. Higher rate. Usually shorter term. Sometimes secured by a second lien, sometimes by a personal guaranty. Typical pricing in 2024 was 12 to 15 percent.

Preferred Equity

Equity that gets paid back before common equity but does not have a lien position. Often used by JV money partners who want a defined return and a cap on upside. Pricing depends on the deal but 15 to 20 percent IRR targets are common.

Common Equity

Your skin in the game. The most junior position. Last to be paid back. First to absorb a loss. The reward for that risk is the largest share of the upside if the project performs.

A Realistic Houston Example

Project: Single-family new construction. Total project cost $400,000. ARV $530,000. Profit target 15 to 20 percent on cost.

• Senior debt (hard money): $300,000 at 75 percent of cost. 11 percent rate, 2 points, 12 month term.
• Gap funding (second-position private): $50,000. 12 percent rate, 1 point, 12 month term.
• Common equity (yours plus JV partner): $50,000 split between you and partner.

At sale, senior gets paid first, then gap, then common equity gets the remaining proceeds split per the operating agreement. If the project underperforms, senior is fully paid before gap sees a dollar, and gap is fully paid before common equity sees a dollar. That is the entire reason the stack exists.

How to Negotiate Each Layer

Senior debt: shop multiple lenders. Compare total cost in dollars, not just rate. Ask about extension fees and prepayment.

Gap funding: usually relationship-based. Bring a clean deal package and a track record, even if your track record is one project. Be transparent about the senior terms so the gap lender can evaluate their position.

Equity partners: paper everything in an operating agreement. Decision authority, capital call procedures, dispute resolution, distribution waterfall, exit triggers. Use a Texas attorney. Skipping this step is the single most common way JV partnerships explode.

Common Mistakes

• Stacking too much debt on a thin-margin deal. The deal does not survive a soft sale.
• Treating gap as senior. Gap lenders are not banks. They expect a position-appropriate return.
• Failing to disclose the full stack to the senior lender. Most senior loan agreements prohibit second liens without consent.
• No operating agreement with equity partners. The deal that goes well still creates a fight over distribution.
• Ignoring carrying cost in the underwriting. Every month of construction costs interest at every layer of the stack.

Where to Build a Stack on a Real Deal

Coffee & Construction Houston walks through real capital stacks on active BEDDIEO and partner deals. The room is The Construction Lounge. The firm is BEDDIEO Construction & Design. You can also learn how I think about this work as a Houston developer.