A mezzanine loan is debt secured by a pledge of the ownership interests in the entity that owns a property, rather than by a mortgage on the property. It sits behind the senior mortgage and ahead of equity in the capital stack, and on default the mezzanine lender forecloses on the pledged interests and takes control of the borrower.
How is a mezzanine loan structured?
The mezzanine borrower is the parent of the mortgage borrower. The property owner borrows the senior loan and grants the mortgage; the entity that owns the property owner borrows the mezzanine loan and pledges its membership interests as collateral. The mezzanine lender has no claim on the real estate, only on the entity that owns it, which places the loan behind the senior mortgage by structure.
The mezzanine loan has its own loan agreement, note and pledge agreement, commonly with a maturity date matched to the senior loan’s and a rate above the senior rate that reflects the junior position.
Illustrative example:
| Item | Amount | Share of value |
|---|---|---|
| Property value | $100,000,000 | |
| Senior mortgage | $60,000,000 | 60% loan-to-value |
| Mezzanine loan | $15,000,000 | 15% |
| Combined debt | $75,000,000 | 75% combined loan-to-value |
| Equity | $25,000,000 | 25% |
The senior lender advances to its own loan-to-value limit; the mezzanine lender advances the next layer, to a higher combined limit, and the equity fills the rest.
What does the intercreditor agreement cover?
The senior lender and the mezzanine lender sign an intercreditor agreement that governs their relationship. Its core provisions are the subordination of the mezzanine lender’s rights, notice of defaults under either loan, the mezzanine lender’s right to cure a senior default within a stated period, a standstill that bars the mezzanine lender from enforcing while the senior lender is exercising its remedies, and the mezzanine lender’s option to purchase the senior loan at par after a senior default.
The agreement also sets the conditions under which the mezzanine lender may foreclose on the pledge and become the owner of the mortgage borrower: a qualified transferee standard the new owner must meet, and a replacement guarantor for the senior loan’s carve-outs.
How does a UCC foreclosure work?
Because the collateral is a pledge of ownership interests rather than real estate, the mezzanine lender’s remedy is a foreclosure under the Uniform Commercial Code rather than a mortgage foreclosure. The lender disposes of the pledged interests through a public or private sale that must be commercially reasonable.
The purchaser at the sale, often the mezzanine lender, becomes the owner of the mortgage borrower. The senior loan stays in place, undisturbed, provided the intercreditor conditions are met. A UCC sale is generally faster than a mortgage foreclosure, which is one reason junior lenders accept the pledge as collateral.
How does a mezzanine loan change the borrower’s covenant and consent picture?
A sponsor with a mezzanine loan has two lenders, two sets of loan documents and an intercreditor agreement layered over both. The covenant tests run on a combined basis: the debt service coverage test counts mezzanine debt service in the denominator, and a combined loan-to-value or debt yield test measures both loans against the property. A default under either loan is commonly a default under the other. Senior loan documents commonly prohibit pledges of ownership interests, so the senior lender’s consent comes first.
Consent rights double. Leases above a threshold, transfers of interests, changes of property manager and additional financing require the approval of both lenders. Hedge requirements apply to both loans when both float, and extension options on a mezzanine loan carry their own tests and notice deadlines alongside the senior loan’s.
How does a mezzanine loan differ from preferred equity?
A mezzanine loan is debt, secured by a pledge, with interest and a UCC foreclosure remedy. Preferred equity is an ownership interest, unsecured, with a preferred return and a control remedy under the operating agreement. The senior lender’s documents often decide which of the two a sponsor can use.
How mezzanine loans show up in LoanBoss
LoanBoss handles the debt fund, mezzanine and preferred equity loans that accompany bridge financing, with different floating indices and daycount conventions, extension testing with notice reminders, and hedge requirements with live mark-to-market and replacement cap costs. Combined tests that include mezzanine debt service sit among the lender-specific DSCR and debt yield adjustments the platform automates.
Frequently Asked Questions
What is the collateral for a mezzanine loan?
A pledge of the ownership interests in the entity that owns the property. The mezzanine lender has no mortgage and no direct claim on the real estate.
Is a mezzanine loan a second mortgage?
No. A second mortgage is a junior lien on the property itself. A mezzanine loan is secured by ownership interests in the property’s owner.
Why do senior lenders allow mezzanine debt?
Because the mezzanine lender has no claim on the property, and the intercreditor agreement gives the senior lender notice, standstill protection and control over who may take ownership of the borrower.
What happens to the senior loan if the mezzanine lender forecloses?
It stays in place. The mezzanine lender, or the purchaser at the UCC sale, becomes the owner of the mortgage borrower and takes the property subject to the senior loan, provided the intercreditor conditions are met.
Does a mezzanine loan count in the DSCR test?
In a combined test, yes. The senior loan documents state whether coverage is measured on the senior debt service alone or on the combined debt service of both loans.
Related Terms
- Subordination
- Preferred Equity
- Loan-to-Value
- Debt Yield
- Bridge Loan
- Bridge and Debt Fund Loans: Extension Tests, Notice Deadlines and What Trips Borrowers
- Loan Portfolio Management for Private Equity Real Estate Funds with Hundreds of Loans
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary