Mezzanine loans

How the structure works

A property owned by a single-purpose LLC takes a first mortgage. Above that LLC sits a parent LLC that owns 100% of it. The mezzanine lender lends to the parent and takes a pledge of the parent’s ownership interest in the property LLC. Nothing is recorded against the real estate.

That design has three consequences:

1. The senior lender must agree. An intercreditor agreement sets what the mezzanine lender can do on default, its right to cure senior defaults, its option to buy the senior loan, and who can take over ownership (a “qualified transferee”).
2. Default moves fast. A UCC foreclosure on a pledged interest can be completed in weeks, which is far quicker than most mortgage foreclosures. The mezzanine lender then owns the property subject to the senior loan.
3. Title insurance works differently. Lenders often buy a UCC policy on the pledged interest, and sometimes a mezzanine endorsement to the owner’s title policy.

Worked example: blended cost and cushion

Illustration only, with hypothetical rates (no public source publishes mezzanine pricing).

A sponsor buys a $100,000,000 property with $6,500,000 of NOI. The senior lender will go to 60% LTV, or $60,000,000. A mezzanine lender will take total debt to 75%, adding $15,000,000.

Layer	Amount	Assumed rate	Annual interest	Cumulative LTV
Senior loan	$60,000,000	6.50%	$3,900,000	60%
Mezzanine loan	$15,000,000	11.00%	$1,650,000	75%
Blended	$75,000,000	7.40%	$5,550,000	75%

Three ways to read this:

• Debt yield. The senior debt yield is $6,500,000 / $60,000,000 = 10.8%. On total debt it falls to 8.7%. (Debt yield = net operating income divided by the loan amount, shown as a percent².)
• Cushion. The property can lose 25% of its value before the mezzanine loan is impaired. A 25% fall in value is a bad year, not a disaster, which is why mezzanine lenders price the way they do.
• Alternatives. If more equity costs the sponsor more than 7.40% blended, mezzanine is accretive. If the senior lender would go to 65% at 6.75%, the comparison changes. Run both in the blended rate calculator.

Where mezzanine is allowed, and where a supplemental loan is better

Senior loan	Mezzanine?	Usually better alternative
CMBS conduit or SASB	Often allowed at origination with an intercreditor; later mezzanine depends on the loan documents	Size the senior loan correctly at closing
Debt fund whole loan	Sometimes, but funds often build future funding into the senior loan instead	Larger whole loan
Fannie Mae or Freddie Mac	Generally not	Agency supplemental loan: Freddie’s reaches 80% combined LTV at 1.25x (7-year term)3
Bank loan	Depends on the bank; many prohibit pledges of ownership	Larger bank loan with more guaranty, or preferred equity
Construction loan	Common in larger projects	C-PACE for qualifying building systems, where the senior lender consents

Prepayment and term

Mezzanine loans usually run to the senior loan’s maturity and carry minimum interest, yield maintenance or a lockout that mirrors the senior loan. A mezzanine lender that expects to earn a set return for a set period will charge for early payoff, so the exit plan matters as much as the rate.

What mezzanine lenders check

1. Their attachment and detachment points: where their loan starts and ends as a share of value, and what value fall wipes them out.
2. The intercreditor terms the senior lender will accept, including cure rights and the purchase option.
3. Sponsor strength and alignment: how much of the sponsor’s own cash is behind them.
4. Senior loan maturity and extension tests, because a senior default becomes their problem.
5. Cash management: whether excess cash is swept to them when the property underperforms.

Common deal killers

• Senior loan documents that ban pledges of ownership, as many agency and bank loans do.
• No intercreditor agreement in time. Negotiating it with a CMBS servicer after closing is slow and sometimes impossible.
• Too little cushion. If the combined LTV leaves no room for a modest value decline, the mezzanine lender will pass or price it like equity.
• Mismatched maturities between the senior and the mezzanine loan.

Where it wins and where it loses

Mezzanine wins when the sponsor wants leverage and control, the senior loan allows it, and the blended cost is below the cost of equity. It loses to preferred equity when the senior lender bans pledges but allows a new equity member, to agency supplemental loans on apartments, and to C-PACE on construction projects with large qualifying systems.