Mezzanine financing is a layer in the capital stack between senior debt and equity. It’s main purpose it to add leverage (debt) to a deal after primary financing has been arranged. With mezzanine financing, you receive additional capital that reduces the cash you tie up in a real estate project, allowing you to use the cash elsewhere. For example, if you take a hard money loan in which you put down 40% cash, a mezzanine loan can reduce your cash commitment to anywhere from 30% to 0%.
Mezzanine Loan Structure
A second mortgage is subordinated debt with a secondary lien on the property. In contrast, a mezzanine loan is not secured directly by the property. Instead, its secured by a lien on the equity (known as membership interests) of the parent LLC that controls the project. In some cases, mezzanine debt has an equity kicker, such as an option that transforms part of the debt into membership interests through conversion or co-investment rights.
If a borrower defaults on a mezzanine loan, the lender has an alternative to the standard foreclosure procedure (which can take a year or longer). Instead, the lender can do a rapid foreclosure (usually measured in weeks) on the parent company using the Uniform Commercial Code’s Article 9. In this process, the lender grabs the membership interests of the parent company, after which it assumes ownership of the project property.
Uses of Mezzanine Financing
Mezzanine financing can be an attractive option for these reasons:
- Extracting equity: You can use a mezzanine loan to cash in on a property’s appreciation. This is a useful alternative when refinancing is inconvenient, perhaps due to a lock-out clause or large prepayment penalty.
- Adding value: A mezzanine loan can be used to enhance the value of an existing property. For example, suppose you have a tired office building that is only half occupied. You bought the property a decade ago using a $12.5 million mortgage (with a prohibitive prepayment penalty) of which $6 million balance remains. You might be able to get a $5 million mezzanine loan and use the proceeds, in part, to renovate the property, thereby reducing the vacancy rate to 5% and boosting the property’s value.
- New construction: You might want to limit the amount of cash you tie up in a new construction project. You use mezzanine debt to reduce your cash commitment and increasing your loan-to-value ratio.
SLG offers mezzanine financing. Contact us today!