Mezzanine Financing - Second Mortgages

Mezzanine Financing Defined—What Is Mezzanine Financing and How Does It Work?

Simply put, mezzanine financing is a way for buyers to increase leverage on a property and to reduce the owner’s capital requirements.

On a refinance, mezzanine financing is a way to pull cash out. On a purchase, it is a way to use less of your own capital. This is beneficial when people have a significant amount tied up in property but little cash.

If you need a clearer idea of what this looks like and how this type of financing can be used, check out the examples we have put together.

Example One: Nancy is under contract to purchase a neighborhood shopping center for $2 million and has a lender lined up to provide $1.4 million (70%) for the first mortgage. For Nancy to complete the purchase, she will need $600,000 (the remaining 30%) in cash.

Alternatively, Nancy may want to consider bringing in a preferred equity or mezzanine debt provider to help her bridge the gap. Assuming that this source is comfortable going up to 85% of the purchase price, they would be willing to provide her with a $300,000 capital investment.

This would mean that Nancy now has a leverage of $1.7 million ($1.4 million from the first mortgage and $300,000 from the preferred equity or mezzanine debt).

Nancy now only has to come to closing with $300,000 of her own money.

Example Two: In a refinance scenario, Jim purchased an apartment building for $1 million and spent the past year renovating the property. He successfully increased the net operating income, and now the asset has a value of $1.5 million. Jim has successfully increased his equity in the property and can use preferred equity or mezzanine debt financing in much the same way that someone would use a home equity line of credit to pull cash out of their primary residence.

Let us assume that Jim has an existing loan balance of $700,000 after purchasing the property for $1 million or 70% of the original value. Now a lender might be comfortable providing Jim with preferred equity or mezzanine debt that would boost his leverage to 85% of the new value for a total loan of $1,275,000.

This would allow Jim to cash out $575,000.

Experienced investors often use terms like these, which laypeople may be unfamiliar with. For this reason, we have put together some terms, definitions, and additional questions and answers below. If you are new to the subject, these may be beneficial to your understanding of the subject as a whole.

In terms of pay structure, mezzanine financing holds senior positions to common equity and is subordinate to the first-mortgage debt.

Like a senior mortgage, it is debt, with a pledge of the ownership entity, and in some cases, a lien will be recorded against the property.

A Quick Clarification About Mezzanine Debt vs. Equity

For those curious about the difference between mezzanine debt and preferred equity, the main difference is that mezzanine debt is a loan while preferred equity is an equity investment.

What throws some people off is that mezzanine debt and preferred equity can be seen as either a loan or just equity. In both structures, the borrower has to pay back the mezz or pref provider before they can cash out their equity.

There are, of course, many other differences between these forms of finance, mainly in how they are structured on the technical side of things. If you want more information, you can call us anytime!

Who Exactly Provides Mezzanine Financing For Real Estate?

No other companies offer our small-balance mezzanine financing. This is why since 1989, Gelt has closed over 10,000 loans!

We Do Flexible Commercial Real Estate Financing

Taking every situation on a case-by-case basis, we offer excellent flexibility. Our goal is to accommodate your needs!