Mezzanine Financing or Mezz Debt:
This provides the borrower with additional funds when the first mortgage lender (Senior Lender) will not lend as much money as you need to complete the transaction. In simple terms Mezzanine Financing is similar to a Second Mortgage. The the collateral is normally not the underlying real estate rather the collateral is most often a pledge of your ownership interests. For example, if your ownership is held in a corporation the owners will own shares of stock. The stock of the company would be pledged to the Mezzanine lender. In the event of a default the Mezzanine lender would foreclose on the stock and take control of the company (and underlying asset).
Most of the ownership structures we see are held in a limited liability company. The ownership of these companies are most often held in units. In other words, like stock the units would be pledged to the mezzanine lender. Because the mezzanine lender comes in at a higher risk level their interest rates are higher than the typical first mortgage lender. Rates for these loans very from lender to lender based on the size, risk profile and property type. Common rates for these loans range from 10% to 15% per annum with fees of 1% to 2%, plus closing costs. These lenders and the Senior Lender will most often require an inter-creditor agreement.
When you first look at the pricing for a Mezzanine loan you might consider running away from this type of loan. Keep in mind the alternative is to bring in more equity. In summary, two things to consider when you need more cash to bridge the gap between the Senior Loan (first mortgage). Secondly, consider the amount needed to close on a transaction the mezzanine loan can be paid off and will go away. Whereas, the equity stays in ownership diluting your ownership and percentage of net income and tax benefits. Additionally, you must looks at the costs of Mezzanine as a blend or effective overall interest rate. When combined with the senior loan (first mortgage). Mezzanine loans can increase the leverage on a property to 80%, 85% and sometimes higher.
Assume the purchase price of a multi-tenanted office building is $10,000,000. You have $2,000,000 equity to contribute towards the purchase. The senior lender with attractive rates will only go to 75%. You are short 5% of the purchase price.
- 5% senior interest rate on $7,500,000
- 13% interest rate for the Mezz portion $500,000
- The effective blended rate would be 5.50%
What would another investor charge to come in with 20% of the required equity? These loans are often on non-recourse loan terms, co-terminus with the first mortgage holder’s loan. We can help select the right mezzanine loan for your property.