Mezzanine financing is subordinate debt that fills the gap between a senior loan and the owner’s equity on a commercial real estate deal, for borrowers who need higher leverage. It is secured by the ownership interests in the property-owning entity, not the property itself. This guide explains how it works.
How does mezzanine debt sit in the capital stack?
In construction, a mezzanine is a floor between two other floors, and mezzanine financing got its name the same way. It sits between debt and equity: mezzanine debt is subordinate to senior debt and senior to common equity. If the loan defaults, the lender can take an equity interest in place of the debt.
Mezzanine debt often carries warrants, which are equity terms attached to the debt that let subordinated debt gain in value. Mezzanine loans also usually have no principal amortization, and part of the return is fixed.
When do borrowers use mezzanine financing?
Borrowers use mezzanine financing to close the gap after a senior lender has made its loan. The borrower puts in less of their own cash, so although the financing costs more, it can raise the return on equity. It is usually sought to support a specific project, and typical transactions include recapitalization, value-add, construction and acquisition. Clopton Capital’s mezzanine financing is for commercial properties only and is available nationwide.
In one example, a company wanted to buy an apartment development in Virginia and use part of its equity in a complex it already owned toward the down payment, without refinancing the liens on its existing properties. Local banks did not have the flexibility for this. Clopton Capital helped the borrower structure a $3 million mezzanine loan, secured against the LLC’s existing portfolio and the new building, and the client never had to refinance.
How is mezzanine debt priced?
Mezzanine debt carries more risk than senior debt, so it costs more. The price depends on:
- the transaction and the property type
- the loan to value and how much mezzanine debt sits on top of the senior loan
- the sponsor and the credit quality of the borrower
- where the debt sits behind the senior loan
- the loan terms and market conditions
Rates vary by lender, property and loan terms. Daily benchmark rates are on our commercial mortgage rates page. For how term, amortization and fees shape the cost of any loan, read our guide to commercial mortgage terms.
How does mezzanine debt compare with preferred equity?
Both fill the gap between a senior loan and the sponsor’s equity, but they are secured and enforced differently. The preferred equity page covers the other side in more detail.
| Feature | Mezzanine debt | Preferred equity |
|---|---|---|
| Security | Pledge of ownership interests | Contractual, through the operating agreement |
| Foreclosure rights | Yes (UCC foreclosure) | No direct foreclosure |
| Priority | Senior to preferred and common equity | Junior to mezzanine, senior to common equity |
| Control rights | Direct enforcement rights | Step-in rights |
| Maximum loan to value | Up to 85% | Up to 90% |
| Amortization | Typically interest only | Typically none |
| Recourse | Typically non-recourse | Typically non-recourse |
Frequently asked questions
What is mezzanine financing?
Mezzanine financing is subordinate debt that fills the gap between a senior loan and the owner’s equity on a commercial real estate deal. Like a mezzanine floor between two stories, it sits between debt and equity. It is repaid after senior debt but ahead of common equity, and it is secured by the ownership interests in the property-owning entity.
Why do borrowers use mezzanine financing?
Borrowers use it to close the gap after a senior lender has made its loan. The borrower puts in less of their own cash, so although the financing costs more, it can raise the return on equity. It is often used for acquisitions, recapitalizations, value-add projects and construction.
Is mezzanine financing available for residential property?
No. Clopton Capital’s mezzanine financing is for commercial properties only, and residential properties are not eligible. Financing is available nationwide, with no limit on which areas of the country or cities a property can be in, and typical transactions include recapitalization, value-add, construction and acquisition.
What should I look for in a mezzanine lender?
Because mezzanine financing can be complex and carries more risk, look for an established lender with a long history of mezzanine loans, reasonable terms, a straightforward application and underwriting process, and full transparency. It also matters that you can speak to a person whenever you need to understand the structure of your loan.
Want to learn more about mezzanine financing? Reach out to Clopton Capital.
