| Detail | Explanation |
|---|---|
| Position | Subordinate to the senior mortgage, senior to all equity |
| Collateral | Pledge of the membership or partnership interests in the property owner |
| Remedy on default | Foreclosure on the pledged interests under the Uniform Commercial Code |
| Governing document | Intercreditor agreement with the senior lender |
| Priced as | A higher rate than senior debt, reflecting its subordinate risk |
How is a mezzanine loan structured?
The senior lender makes a mortgage loan to the property-owning entity. A separate parent entity above it borrows the mezzanine loan and pledges its entire ownership of the property owner as collateral. The mezzanine lender never holds a mortgage on the building. Its claim is on the equity that controls the building.
That structure is why mezzanine financing exists at all. Many senior loan documents prohibit a second mortgage on the property, and a pledge of equity one level up keeps the senior lien clean while still giving the mezzanine lender a path to control. The commercial real estate capital stack guide shows where each layer ranks.
What happens if the borrower defaults on mezzanine debt?
Because the collateral is personal property (the ownership interests), the mezzanine lender usually enforces through a Uniform Commercial Code sale instead of a real estate foreclosure. A UCC sale can move faster than a judicial mortgage foreclosure in many states. The buyer at that sale steps into ownership of the property entity, still subject to the senior loan.
The intercreditor agreement sets the limits. It typically gives the mezzanine lender notice of senior defaults, cure rights, a purchase option on the senior loan, and qualifications a replacement owner must meet before taking control.
Worked example
In this hypothetical example, a sponsor acquires a property for $40,000,000 in total cost. The senior lender caps its loan at 60% of cost. A mezzanine loan adds 15%, so total debt reaches 75% and the sponsor's equity check falls to $10,000,000 in cash. Rates are assumed for illustration and are not quotes.
| Layer | Amount | Share of cost | Assumed rate |
|---|---|---|---|
| Senior mortgage | $24,000,000 | 60% | 6.50% |
| Mezzanine loan | $6,000,000 | 15% | 12.00% |
| Sponsor equity | $10,000,000 | 25% | Residual |
| Blended cost of the $30,000,000 of debt | 7.60% |
When does mezzanine financing make sense?
The cost is real. Every dollar of mezzanine debt carries more interest than senior debt, adds a second set of covenants, and tightens combined coverage. If the senior lender will not allow a pledge of equity, preferred equity is the usual alternative, and the mezzanine debt vs preferred equity comparison walks through that choice. Capital Partners arranges mezzanine and preferred equity alongside the senior loan. Start with the loan sizing calculator to see what the senior loan supports, then submit the deal to size both layers together.
- The senior loan is sized by loan-to-value or debt yield below what the business plan needs
- The sponsor wants to keep control and upside instead of bringing in a co-GP
- A recapitalization needs to return equity without selling the asset
- The senior loan documents permit a mezzanine loan and set the conditions for one
Common questions
Is mezzanine financing debt or equity?
It is debt. The borrower owes fixed interest and principal, and the lender's remedy is foreclosure on pledged ownership interests. Its link to equity is the collateral, which is an ownership interest instead of real estate.
Does a mezzanine lender get a mortgage on the property?
No. The mezzanine lender's collateral is a pledge of the ownership interests in the entity that owns the property. The senior lender holds the only mortgage.
Can I add mezzanine debt to an existing loan?
Only if the existing senior loan documents allow it or the senior lender consents. Many permanent loans restrict any additional financing, so check the transfer and encumbrance sections before pricing a mezzanine loan.
What is an intercreditor agreement in mezzanine financing?
It is the contract between the senior and mezzanine lenders. It sets notice and cure rights, whether the mezzanine lender can buy the senior loan, and who is allowed to take over ownership after a mezzanine foreclosure.
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