Mezzanine loan or preferred equity for the gap above your senior loan

The capital stack in one picture

Position	Paid	Remedy
Senior mortgage	First	Foreclosure on the property
Mezzanine loan	After the senior	UCC sale of the ownership interest
Preferred equity	After all debt	Control rights or forced sale
Common equity (you)	Last	None; you own what is left

Both middle layers fill the same gap. The difference is how they are protected and what they can do to you when the plan slips.

Filling a $6 million gap each way

Illustration. A sponsor buys a $40,000,000 property with $2,200,000 of NOI. The senior lender offers 60%, or $24,000,000, interest-only at an illustrative 6.20%. The sponsor wants to put in 25% of the price as equity and needs $6,000,000 more. One offer is a mezzanine loan at 11.0% current pay, coterminous with the senior, with 12 months of minimum interest. The other is preferred equity at a 12.0% preferred return (8% paid currently, 4% accrued) with a 1.30x minimum multiple on early redemption.

Annual cost (illustration)	Senior + mezzanine	Senior + preferred equity
Senior interest	$1,488,000	$1,488,000
Gap capital, paid in cash	$660,000	$480,000
Gap capital, accrued	none	$240,000
Blended cost of the $30,000,000	about 7.16%	about 7.36%, part accrued
Coverage the senior lender sees	about 1.02x combined	about 1.48x (senior only)

Two things decide it. First, cash flow: preferred equity accrues part of its return, so it takes less cash out of the property each year. Second, the senior lender’s view: mezzanine shows up in combined coverage, and 1.02x leaves almost no room. Preferred equity usually sits outside the senior’s test, which can make the senior loan larger or the structure possible at all. Run your own blend in the blended rate calculator.

Now repay early, at month 18, after a sale.

Early payoff (illustration)	Mezzanine	Preferred equity
Return already paid or accrued	about $990,000	about $1,080,000
Minimum the documents require	12 months of interest, already met	1.30x on $6,000,000, so $1,800,000 of return
Extra cost to exit	none	about $720,000

The preferred investor’s multiple is what makes an early exit expensive. If you might sell early, negotiate the multiple down or have it step down over time.

What each investor checks

Mezzanine lender: the senior loan documents and whether they permit the pledge, the intercreditor terms (cure rights, purchase option, what counts as a senior default), the business plan, and the value cushion under its position. It also usually requires UCC title insurance on the pledged interest.

Preferred equity investor: the operating agreement it will join, the triggers that hand it control (missed payments, budget variances, a failed refinance date), the sponsor’s track record, and the senior lender’s consent to its rights.

Where each one wins

Mezzanine wins when the senior lender allows it, the sponsor wants to keep every control right while performing, the structure is a CMBS or debt fund senior loan already built for it, or an early exit is possible.

Preferred equity wins when the senior loan prohibits subordinate debt or pledges, when cash flow is tight and part of the return can accrue, or when a recapitalization needs capital that ranks ahead of the remaining partners.

Neither wins when a supplemental loan or a larger senior loan can fill the gap. That is usually the case on stabilized agency apartments.

The costs people miss

• Intercreditor and recognition agreements. Both sides’ counsel, often the longest item to close.
• Senior lender consent fees. Charged for signing off on the subordinate investor and its rights. Ask early.
• Control triggers. A preferred equity takeover right on a single missed distribution is a harder term than most mezzanine defaults.
• Accrued return compounding. An accrued preferred return often compounds, so the payoff at redemption grows faster than the headline rate suggests.
• Origination fees on both, charged on the gap amount.

Need gap capital on a purchase or recapitalization? Send the senior terms and the business plan, and we will price mezzanine and preferred equity side by side.