A typical subordinated (i.e. 2^nd mortgage position) loan carries a significantly higher risk factor than a first position loan.  If a 2^nd position mortgage loan goes into default the superior lien in the first position must be paid off in full first in the event of foreclosure proceedings. This makes subordinated real estate secured loans unappealing to most lenders, traditional or private.

On the other hand, a mezzanine loan is a unique type of subordinate loan which is secured by stock, or other ownership stakes, in the company which owns the property rather than only by a subordinate trust deed on the property itself. This distinction in security allows the lender to seek recourse in the event of loan default by taking over majority ownership of the holding entity. The lender is then in a position to control the property and sell it if that is the best option. This control does not negate the necessity of eventually paying back the superior loan, but it does give the lender more options if the worst case scenario comes to pass. Because of this flexibility, mezzanine loans have become an attractive alternative to conventional subordinate loans which are secured by the same property as the initial superior lien.

Structure of Mezzanine Loans

Structuring a mezzanine loan can be a complicated and expensive process, but there are benefits to both lender and borrower (see Part 2 of our mezzanine loan blog for information on structuring). The lender benefits from the foreclosure options noted above. The borrower benefits from an increased ability to leverage the property beyond the typical 60-70% LTV that is available through first position hard money loans. Using mezzanine loans, many borrowers can obtain a CLTV (combined loan to value, which represents all loans made on the property) as high as 90-95%. Mezzanine loans are typically secured by borrowers who need to fill a financing gap in a leveraged buyout of a company or in a development project.

Although in some instances mezzanine loans may be obtained from the same lender as the primary loan on the property, even if it is through a bank, or by a secondary source, this is not a common occurrence. Most mezzanine loans are funded by private capital lenders including hedge funds as well as local hard money lenders.  It is important for borrowers to keep in mind that this type of capital is usually more expensive due to higher interest rates than what lenders ask for the typical initial asset-secured loan.  Rates for high leverage mezzanine loans typically start at around 15% and move into the mid 20% range. Full disclosure:  Montegra Capital only funds first position secured real estate loans and does not fund mezzanine debt.

This blog was written by Bob Amter, President of Montegra Capital Resources, LTD., a Colorado hard money lender.  [google_authorship] has been in the private capital lending business for 41 consecutive years.