Mezzanine Debt, Explained: The Higher Rung of Real Estate Credit

Mezzanine debt is a loan that sits behind the senior loan and ahead of all the owners. It is usually secured not by the building but by the shares of the company that owns the building. The mezzanine lender is paid after the senior lender and before any equity, and earns a higher fixed rate for that second place in line. It is still credit: the return is capped at the agreed rate.

What you are when you invest

You are a lender in second position. You receive fixed interest, sometimes partly paid in cash and partly added to the loan, and your principal back at a sale or refinance. You do not share in profits above your rate.

What protects you

• The equity below you. Preferred and common owners lose before you do.
• A pledge of the ownership. If the borrower defaults, you can take over the company that owns the building, often faster than a mortgage foreclosure, because it follows the commercial-law process (UCC) for pledged shares.
• An intercreditor agreement. A contract with the senior lender that sets your rights to cure defaults and step in.

What can go wrong

• A thinner cushion. In a hypothetical $100 million building with a $55 million senior loan and $15 million of mezzanine, the mezzanine lender loses once the value falls below $70 million, a 30% drop.
• Taking over means taking on the senior loan. If you step in, you inherit the building and its senior debt. You may need to inject money to keep it current.
• The senior lender controls a lot. Intercreditor terms can limit what you can do and when.
• Capped upside. A strong sale does not raise your return.

What the return looks like

Illustratively, mezzanine loans often target low to mid teens, around 11% to 14% a year, above senior loans and below most equity. The extra yield is the price of second place.

Who it fits

Investors who want a defined, contractual return higher than a senior loan, can accept a thinner cushion and understand that, in a bad case, they may have to become owners to protect their money.

How we look at it

For mezzanine, we focus on two numbers: how far the value can fall before we lose, and what it would cost us to take over and carry the property if we had to. If we would not want to own the building at that price, we do not want to lend behind the senior loan on it. Compare with preferred equity, which sits at a similar level but is equity, not debt.

Frequently asked questions

Is mezzanine debt secured by the property?

Usually not directly. It is secured by a pledge of the shares of the company that owns the property.

Mezzanine or preferred equity: which is safer?

It depends on the documents. Mezzanine is debt with a faster remedy; preferred equity relies on contractual rights inside the ownership company. Read the remedies, not the label.

Infinity⁹ (Infinity Capital Asset Management, LLC) is an Exempt Reporting Adviser with the SEC, CRD# 330526. This article is educational and does not constitute legal, tax or investment advice, or an offer to sell or a solicitation of an offer to buy any security. Examples are hypothetical and simplified, and figures are illustrative ranges, not projections. Any offering is made only through definitive documents and only to accredited investors.