Mezzanine Debt

Mezzanine debt, often referred to as "mezz debt," is a type of subordinate financing that is ranked between senior debt and equity in the capital stack of a real estate deal. This means that in the event of default, mezzanine lenders are paid after senior lenders but before equity holders.

Key characteristics of mezzanine debt include:

High Yield: Due to its higher risk profile compared to senior debt, mezzanine debt typically comes with higher interest rates, making it a more expensive form of financing.

Convertible to Equity: Mezzanine debt often includes an equity component, such as warrants or a conversion feature, which gives the lender the right to convert their debt into an ownership or equity interest in the company if the loan isn't paid back in time.

Collateral: Unlike traditional secured loans where the collateral is usually the physical property, mezzanine loans are often secured by a pledge of the ownership interests in the entity that owns the property.

Flexibility: Mezzanine financing can provide increased loan-to-value ratios and fill the gap between senior debt and equity, increasing the overall leverage of a transaction.

Subordination: Mezzanine lenders are subordinate to senior lenders in terms of repayment priority, but have a higher priority than equity holders.

Mezzanine financing is often used in real estate to increase the leverage of a deal without the need for additional equity. It can be an attractive financing option for developers and investors looking to reduce their equity requirement and potentially increase their return on equity. However, the increased leverage also comes with increased risk due to the higher cost of capital and the increased likelihood of default if cash flows are insufficient to service the debt.