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Practical Example: Building an REI Company Capital Stack

10 min
5/6

Key Takeaways

  • A multi-strategy REI company needs $480K-$900K annually across wholesale, flip, and BRRRR strategies.
  • The capital stack layers personal capital, hard money, private lenders, conventional refinance, and credit lines.
  • Blended cost of capital must be 5+ percentage points below average return on deployed capital.
  • Capital stack optimization reduces external dependence from 80% to 50% over 4 years as the portfolio grows.

The capital stack—the combination of funding sources used to acquire and improve properties—determines the REI company's returns, risk exposure, and growth capacity. This practical example walks through building a capital stack for a multi-strategy REI company, demonstrating how different capital sources are layered for optimal results.

1

Assessing Capital Needs by Strategy

Keystone REI operates in Birmingham, AL with three active strategies. Wholesale: requires $5K-$10K in working capital for earnest money deposits and marketing—funded from operating cash flow. Flips: requires $80K-$120K per project for acquisition and renovation—funding needed for 3 concurrent projects ($240K-$360K total). BRRRR Rentals: requires $60K-$90K per acquisition for purchase and rehab—funding needed for 4-6 acquisitions per year ($240K-$540K). The company has $100K in retained earnings and the owner has $50K in personal capital available. Total capital need: $480K-$900K annually. The gap between available capital ($150K) and needed capital ($480K-$900K) must be filled by external sources.

2

Building the Capital Stack

Keystone builds a layered capital stack. Layer 1—Personal Capital ($150K): used as seed capital for the first flip and first BRRRR acquisition, plus operating reserves. No cost of capital, maximum flexibility. Layer 2—Hard Money ($300K available, 12% interest, 2 points): used for flip acquisitions with 6-month terms. Provides fast closing (7-10 days) essential for competitive acquisition. Total annual cost: approximately $36K in interest and fees. Layer 3—Private Lenders ($200K from 3 investors, 10% annual interest): used for BRRRR acquisitions. Lower cost than hard money, longer terms (12 months), and relationship-based flexibility. Total annual cost: approximately $20K. Layer 4—Conventional Refinance (75% LTV on stabilized rentals): used to exit hard money and private money after BRRRR renovations are complete. Locks in long-term 30-year rates (6.5-7.5%) that the rental cash flow supports. Layer 5—Line of Credit ($50K, 8% variable rate): used as bridge funding for earnest money deposits, unexpected renovation costs, and short-term cash flow gaps. The blended cost of capital across the stack is approximately 9.5%, which must be below the company's average return on deployed capital (target: 18-25%) by at least 5 percentage points.

3

Optimizing the Capital Stack Over Time

Capital stack optimization reduces the blended cost of capital and increases availability. Year 2 optimizations: as the track record grows, negotiate hard money rates down to 10% and 1.5 points (saving approximately $6K annually). Add 2 more private lenders at 9% (reducing the private capital blended rate). Obtain portfolio lending relationships for BRRRR refinances at more favorable terms. Year 3 optimizations: transition from deal-by-deal private lending to a small fund structure—raise $500K at 9% with a 3-year commitment, reducing administrative overhead and providing committed capital for faster deal execution. Establish a larger line of credit ($100K) with the growing portfolio as collateral. Year 4 optimizations: the rental portfolio generates $50K+ annual cash flow that reduces reliance on external capital. Begin using rental cash flow to fund portions of new acquisitions, reducing the external capital need and associated costs. The capital stack matures from 80% external / 20% internal in Year 1 to 50% external / 50% internal by Year 4.

Guided Practice: Building Keystone REI's Capital Stack

Keystone REI in Birmingham needs $480K-$900K annually for 3 concurrent flips and 4-6 BRRRR acquisitions, with $150K available internal capital.

  1. 1Calculate capital needs by strategy: wholesale ($10K), flips ($360K for 3 concurrent), BRRRR ($540K for 6 acquisitions).
  2. 2Inventory available internal capital: $100K retained earnings + $50K personal = $150K.
  3. 3Identify the capital gap: $480K-$900K needed minus $150K available = $330K-$750K external capital required.
  4. 4Structure Layer 2 (hard money at 12% + 2 points for flip acquisitions) providing fast closing capability.
  5. 5Structure Layer 3 (private lenders at 10% for BRRRR acquisitions) providing lower cost and longer terms.
  6. 6Plan Layer 4 (conventional refinance at 75% LTV) for BRRRR exit, recovering capital for recycling.
  7. 7Establish Layer 5 (line of credit at 8%) for bridge funding and unexpected costs.
  8. 8Calculate blended cost of capital (9.5%) and verify it is 5+ points below target return (18-25%).

Key Takeaways

  • ✓A multi-strategy REI company needs $480K-$900K annually across wholesale, flip, and BRRRR strategies.
  • ✓The capital stack layers personal capital, hard money, private lenders, conventional refinance, and credit lines.
  • ✓Blended cost of capital must be 5+ percentage points below average return on deployed capital.
  • ✓Capital stack optimization reduces external dependence from 80% to 50% over 4 years as the portfolio grows.

Sources

Common Mistakes to Avoid

Building a capital stack with a blended cost too close to the expected return

Consequence: Any market fluctuation or deal underperformance eliminates profitability, turning deals from profitable to break-even or loss-making.

Correction: Ensure a minimum 5-percentage-point spread between blended cost of capital and target return before funding any deal.

Relying on a single capital source for all acquisitions

Consequence: If that source becomes unavailable (lender policy change, investor withdrawal), the entire acquisition pipeline stalls.

Correction: Layer multiple capital sources (hard money, private lenders, conventional refinance, credit lines) so no single source is critical to operations.

Test Your Knowledge

1.What is the minimum spread between blended cost of capital and average return on deployed capital?

2.What is the target for reducing external capital dependence over 4 years?

3.In the capital stack, what role does Layer 4 (conventional refinance) play in the BRRRR strategy?

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