Mezzanine loans are especially well-suited to complex commercial real estate transactions, in which a property owner must make use of all available avenues of financing to ensure a deal moves forward. When working with investments worth millions of dollars, this sort of financing can be essential to the success of all parties involved. Mezzanine financing is also inherently risky, both for the property owner and for the mezzanine lender.
Mezzanine loans can be used for multiple purposes in commercial real estate investments. First, because a primary mortgage lender for commercial real estate will rarely cover more than 50-60% of the value of the property, a mezzanine loan can help the buyer make the purchase without using as much of their own cash. Second, a mezzanine loan can be used as bridge financing for a property can be renovated or improved. Once the work is complete, another first mortgage may be obtained based on the newly appraised value of the property. Finally, a mezzanine loan can also be used in a way that is analogous to a home equity loan. For a property in which the owner has a great deal of equity, a mezzanine loan can allow the owner to receive cash from the property.
Mezzanine investors recognize that they are last in line to get paid in the event that a property owner defaults. That is why they may structure mezzanine loans as a hybrid of debt and equity. The mezzanine investor will receive a significantly higher interest rate than the other lenders providing financing to the owner, as well as an equity stake in the property. This can help the mezzanine investor recoup more of their losses in the event of default.
One reason a buyer in commercial real estate may seek out mezzanine financing is that it can help drive up their return on equity. Even if the buyer can afford to invest enough money to purchase the property with a first mortgage as the sole source of financing, it can be a smart business move to bring in a mezzanine investor to take on a portion of the equity. While the owner’s share of the profits from the property may be less than if they had a greater share of equity, their overall return on equity can be higher.
Mezzanine loans are a tier of financing in commercial real estate transactions that can be advantageous for both lender and borrower. They can generate high returns for investors and put deals within reach of buyers that would otherwise not be feasible.