What is a capital stack in community development?
Visitor Question: I'm on a committee the mayor appointed to look into what we need to do to get more moderately priced housing built in our little city. Yesterday we had a visiting expert from a nearby larger city come to speak to us. He was talking to us about building a better capital stack. I for one had no idea what he was saying, and I suspect others did not know either. Nobody mentioned that in our discussion after he had left.
So my question is pretty simple; I just want to know what in the world this is, and whether you agree that "building a capital stack" is important.
Editors Reply: The idea behind the capital stack idea is that usually in a housing project, or any large real estate development and many small ones, there is more than one source of funding for the project. In the very simplest terms, the stack idea refers to the fact that those who lend or invest in a project have a certain pecking order for repayment in the event that something like natural disaster or bankruptcy goes wrong.
Just like a stack of pancakes, someone is on top and first in line for repayment in that event. That entity or even person is often called the senior lender. Below the top, just as with pancakes, there is an order. The next-to-top pancake, or in our case contributor of funding for the project, is second in line in the event of default.
That is what a capital stack is. Even projects in smaller cities, and especially projects in distressed areas, may have a good number of layers of funding. Eight or ten isn't unusual for a housing project of any size.
Now as to your visiting expert's statement that you need a better capital stack, that is probably nonsensical when applied to an entire community. Perhaps your expert intended to get across that there need to be more potential lenders who are willing to participate in making loans for housing projects. If a smaller city has only one bank that wants to do housing deals, that probably won't fit all circumstances.
Similarly, if every bank or other lender in town (such as a CDFI) in town is really picky, it could be hard to assemble an appropriate capital stack in the case of any one prospective project.
Say you have only one bank really open to the kinds of projects your city needs, and that bank will only finance 80 percent of the project, which would be a common stance to take. Not every developer will be able to finance the other 20 percent by themselves, so you also need secondary lenders or equity partners. (The difference is that a lender is just making a loan, much as your mortgage company or auto finance company does, whereas an equity partner actually is taking an ownership stake and may reap more financial benefits than simple repayment with interest if a property is sold.)
If there are no available secondary lenders or development entities or individuals willing to take on part of the burden of the 20 percent, or whatever percentage the senior lender will not finance, then you can see that the housing project would not go forward.
So it's important that your city have or cultivate several possible sources of funding for a housing development, in addition to the developer himself or herself. The developer often furnishes the smallest amount of equity for some types of housing projects, so you need some flexibility. I your city is too small to have a choice of a few or several lenders or potential equity partners that might invest, then you should be building relationships with banks and investors in a nearby larger city so that some options for financing are available for developers
We would be curious to know if there have been specific examples of proposed developments in your city not being able to move forward because of not being able to assemble a viable capital stack. The next time said expert appears, or the next time your group is meeting, that would be a good question to ask to begin to understand whether or not a developer in your city is likely to encounter difficulty in putting together a capital stack.
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