Mezzanine loans are a popular form of subordinate financing in today's apartment finance market. This form of financing is most often used as a financial instrument to reduce the equity requirement of the borrower or investor. Traditionally, they sit in the second lien position and are a combination of both debt and equity. This equates to an increased return for the lender due to the increased risk of being in the second position and reducing the borrower's "skin in the game."

In many scenarios, developers looking to maximize their IRR also need to maximize leverage, since the cost of equity is typically more expensive than that of non-recourse debt. In other situations, developers simply need more leverage to boost liquidity and have more funds available for other opportunities. Regardless of the situation, for those looking to build their capital stack, the first options worth looking into should be mezzanine financing and preferred equity.

While it is quite commonplace that multifamily and commercial mezzanine lenders prefer to have a recorded second mortgage as security, a pledge of stock is also an option for securing mezzanine financing; this deal structure is commonly referred to as preferred equity. Although there usually isn't any true equity or waterfall requirement, the security itself is considered equity. Therefore, collateral is the only substantial difference between mezzanine loans and preferred equity agreements.

Sample Mezzanine Financing Loan Terms For Multifamily and Commercial Property Loans 2021

Amount: $3 million and up

Term: Coterminous with first (typically between 5-7 years)

Interest Rates: Typically between 9% - 16% (interest only)

Fees: 3% - 6%

Maximum LTC: 85% 

Pros:

• Increases leverage and IRR

• Interest is tax-deductible

• Flexible options include equity kickers for reduced interest rates and PIK toggles for reduced interest payments

Cons:

• Can be extremely expensive (up to 20% for some borrowers)

• Not allowed by all lenders

• High fees and additional legal costs

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