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  Category: Articles » Finance » Loans » Article

Commercial Loans: How Mezzanine Debt Closes the Deal

By Craig Higdon

This is the "answer" to a question I received this past week concerning a class of commercial real estate loans called "mezzanine" debt. If you've never heard of it, don't worry. It's usually used by fairly substantial commercial real estate developers and investors in situations where the existing debt doesn't go far enough to get the property financed. Mezzanine debt is the modern-day equivalent of second trust deeds.

First, you need to understand that "modern" commercial lenders are a jealous lot: Most of them, whether bank, CMBS+ mortgage bank, and sometimes life insurance companies won't allow a junior lien to be recorded against a property where they have a first trust deed. There are several reasons for this, but the bottom line is that real estate investors would have needed a great deal of cash to get larger transactions done until the mezzanine lenders showed up. Here's an example:

A real estate investor has owned a large shopping center for 5 years and wants to sell it. When he bought it, he got a 75% LTV loan of $6 Million on his $8 Million purchase price using a Conduit+ loan from a mortgage bank. Rates went down from the time he bought it, and it has appreciated to $16 Million in the same time, and his commercial loan balance is now $5.5 Million. Because this is a Conduit loan, our seller would face a prepayment penalty in the range of $600,000 to $1 Million! And since they don't allow second trust deed on the property, the Buyer would have to come up with over $10.5 Million to buy it! Not.

Mezzanine mortgage lenders get around this problem by lending on collateral other than the property. Commercial loan Conduits require borrowers to create a special entity, usually a LLC, to own the property to protect them in the event the borrower files for bankruptcy. The Mezzanine mortgage lender uses the membership interests of the LLC as collateral for their loan instead of the property. So in our example, the Mezzanine lender steps up with a loan as large as $7.3 Million (this would bring the combined loans to 80% of the purchase price), depending upon the lender's debt service requirements. Voila! Purchase accomplished!

Mezzanine lenders also play an important role in large construction loans, too. Unfortunately, these types of commercial loans aren't available to regular mortals. The smallest Mezzanine loans tend to be in the $2 Million the $3 Million range. But it's good to know they're there when you do need one!

+CMBS: Commercial Mortgage Backed Securities, usually arranged by major Wall Street investment banks who are referred to as "conduits."
About the Author
WANT TO USE THIS ARTICLE IN YOUR E-ZINE OR WEB SITE? You can, as long as you include this complete blurb with it: Craig Higdon, "The Investment Property Insider," works as a commercial mortgage broker. He publishes the weekly "Investment Property Insider" e-zine ( Sign up now and get a complimentary report on commercial financing techniques.

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  Some other articles by Craig Higdon
Effective Real Estate Strategies for Slow Markets
Speeding Commercial Real Estate Sales in Slow Markets Effectively building commercial real estate wealth requires the ability to spot a great ...

How to Purchase Underperforming Properties with Construction Loans
A SECRET STRATEGY TO TURN LOSERS INTO WINNERS I received a question from a Realtor last week that will ...

Commercial Real Estate Syndication: Controlling the Property
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Apartment Loans: Common Multifamily Misconceptions
I had the opportunity this past week to answer a number of questions about apartments. I find a great deal of misinformation out there concerning the financing of this excellent type of income ...

Commercial Real Estate Syndication: Property Selection and Purchase, Part 2
We've been discussing the process of assembling groups of investors for the purpose of acquiring income producing commercial real estate. The ...

Commercial Real Estate Syndication: Property Selection and Purchase, Part 1
Let's assume that you've decided to start assembling groups of investors to buy investment real estate. If you followed my Roadmap of a successful syndication in my previous articles (Part 1 ...

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