What it is
Mezzanine debt, or "mezz," is a loan that fills part of the gap between the senior mortgage and the sponsor's equity. It's subordinate to the senior loan: the senior lender gets paid first. Because it takes more risk, it carries a higher interest rate.
The key difference from a second mortgage is security. A mezzanine loan is usually not secured by the property itself. It's secured by a pledge of the equity interests in the entity that owns the property.
Where it sits
In the capital stack, mezzanine debt sits above preferred equity and common equity, and below the senior loan.
| Layer | Example amount | Cumulative leverage |
|---|---|---|
| Senior loan | $12,000,000 | 60% |
| Mezzanine loan | $2,000,000 | 70% |
| Preferred equity | $2,000,000 | 80% |
| Common equity | $4,000,000 | 100% |
Illustrative, on a $20,000,000 property.
How it works
- Security. The mezz lender holds a pledge of the membership interests in the borrower entity. If the borrower defaults, the mezz lender can foreclose on those interests, often through a UCC sale, and take control of the entity that owns the property. This process is generally much faster than a mortgage foreclosure.
- Intercreditor agreement. The senior and mezzanine lenders sign an agreement that sets out each one's rights: cure rights, purchase options, consent rights and what happens on default.
- Pricing. Higher rate than senior debt, and sometimes fees or a share of upside.
- Senior lender consent. Many senior lenders limit or prohibit subordinate debt. Some, including CMBS and agency programs, allow mezzanine debt only under specific conditions.
Why sponsors use it
Mezz increases total leverage without the sponsor giving up as much ownership as it would by raising more equity. It's common on acquisitions, recapitalizations and construction where the senior lender's maximum LTV or LTC leaves a gap.
What lenders look at
Both lenders look at combined metrics. Combined LTV, and combined debt service coverage including the mezz payments, tell them how much cushion is left for everyone.
Common mistakes
- Not checking the senior lender's rules first. Arranging mezz on a loan that prohibits it wastes weeks.
- Ignoring combined coverage. A deal that works on senior DSCR can struggle when mezz interest is added.
- Treating it like equity. Mezz has a maturity date and payment obligations.
In the package
Show the full capital stack with each layer's terms and combined metrics. Lenders reviewing the senior loan want to see the subordinate structure up front.