In Commercial Lending What the Heck is a Mezzanine Loan?

A mezzanine loan is similar to a second mortgage with one exception – A mezzanine loan is secured by the stock of the company that owns the property, as opposed to the real estate.  If the company (usually a Limited Liability Company) fails to make payments, the mezzanine lender can forecloses on the stock in a matter of a few weeks.  In most states it often takes up to 18 months to foreclose a mortgage.  Bottom line is that if you own the company that owns the property, you control the property.

One hard money commercial lender I know once had to foreclose on a mortgage in New York and it took almost two years.  Only in New York!  In stark contrast, a mezzanine loan is secured by the stock of a company.  Because it’s personal property it can be seized much faster.

It is hard to find a mezzanine commercial lender who will handle a request for loans under $2 million, but it is occasionally possible to find a commercial lender who will handle a mezzanine loan for as small as $1 million.

Additionally, commercial lenders who handle mezzanine loans want big projects.  If the property you are trying to finance is not worth close to $10 million, you will have a hard time attracting any commercial lenders who will handle a mezzanine loan for you.

Actually there are only three typical uses for mezzanine financing.  Let’s suppose the owner of a $10 million shopping center has a $5 million first mortgage from a conduit. A conduit is short for REMIC, which stands for a Real Estate Mortgage Investment Conduit.  (More about these in other articles) J Say the owner wants to pull out some equity, but he can’t simply refinance the shopping center because the first mortgage has either a lock-out clause or a huge defeasance prepayment penalty.  In this case, he could probable get a $2.5 million mezzanine loan from the right commercial lender to free up the cash he needs.

Now suppose an experienced investor in an office building wants to buy a partially vacant office complex in a great location.  And once again, let’s assume that the purchase price is $10 million – when this office building is still partially vacant – and that the conduit first mortgage is $5 million.

You might be surprised, but if you can find the right mezzanine commercial lender might be willing to lend up to $4 million!  And you say, “but, isn’t that a 90% LTV?  Yes, it is.  But when the vacant space if rented – and remember that this buyer is a “Pro” – the property will increase to $12 million in value.  In a flash the mezzanine commercial lender is back to a 75% LTV and his rationale is obvious.  You call a deal like this a value-added deal.

The last use of mezzanine loans is for new construction.  Just suppose a developer wants to build a 400 room hotel smack dab across the street from Disneyland.  Hotels today are not in favor, so a commercial construction lender might only be willing to give you a loan of around 60% loan-to-cost.  If the total cost was $20 million, the developer would usually come up with 40% of $20 million or $8 million.  That’s a lot of smackaroos!

A $3 million mezzanine loan from the commercial lender solves this developer’s problem.  The commercial construction lender would advance $12 million while the mezzanine commercial lender would make a $3 million mezzanine loan, and the developer would “only” have to come up with $5 million.  That little mezzanine loan saved the deal.