How to Analyze Debt (Mezz/B Trache, Anything Outside of Senior) as an Investor

How do you assess if mezz, B traches, etc when looking at a deal. Do you say I am comfortable with a 1.4x DSCR, 8% Dy, 55% LTV on this asset at the senior level since it's a hotel in a Tier 1 market with a good sponsor and at the Mezz level I would be comfortable with a min 1.75x DSCR, 12% DY, 65% LTV and X% as your rate of return overall?

If anyone has an example of say a $10mm deal, existing senior loan at 55% LTV, cashflowing asset with a strong sponsor. I am guessing you want safer metrics for riskier assets and will go safer for multi vs hotel.

I also don't fully understand A and B tranches, are B tranches B-pieces?

Comments (7)

  • Principal in RE - Comm

Whenever we have looked at mezz deals of any asset class, we are basically underwriting the property at the current operating levels and then adding in the scenario of our piece of the capital stack included. If the deal is still cash flowing and there's buffer between the different debt obligations then we feel comfortable that the sponsor will be able to pay us whatever the rate was that we underwrote. If the deal isn't penciling or there's a small buffer once obligations are paid, then their ability to pay us isn't that strong and we would feel less confident.

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  • Analyst 2 in RE - Comm

Got it so it's making sure there's enough cash flow after layering on a mezz piece, but you end up looking at DY, DSCR, and overall LTV to decide if you want to invest right? As an outside investor how do you value the mezz piece do you do similar to a senior lender and say the least of these three and that's your offer? 

Also, how do these opportunities come up. Is it a sponsor (the owner of the property) saying hey our lender wants to reduce their risk from 70% LTV to 55% (which I have never heard of, but maybe it's a lender wants a paydown during bad times and owner doesn't want to put more equity in) and they say we want to fill that with mezz, what's the highest LTV you can get to and what would you pay?

Or is it more from debt/equity brokers saying we have this opportunity? I feel the deals without brokers are pretty common since owners know each other and maybe it's also a situation of hey our LTV is now 55%, we want to take out some equity since values have come up would you be interested in coming in for 15%? How does it work with target LTVs, values you take, and what were the target return metrics generally that you felt comfortable with at the time. 

Assuming for this too you value the asset and say senior lender UW $100mm value at the time today due to xyz we think value is $80mm. Loan is currently $50mm of that maybe we can layer on mezz at a cheaper valuation because they can do xyz very easily to get back to $100mm value?

  • Associate 2 in RE - Comm

A Notes have payment priority over B Notes, implying that a B Note carries a higher interest rate for the additional payment risk.

& I may be talking out of my ass, but I would imagine that the mezz lender would have a looser credit box than the senior lender (willing to take on a lower DSCR & Debt Yield) considering that they are adding additional debt service to the stack.

fattestchimp821, what's your opinion? Comment below:

Usually, a lender will not be issuing both senior and subordinate debt. Senior lenders are your life companies and banks that have stricter underwriting standards. Mezz lenders will typically be private debt funds or family offices looming for higher yields and can take on that additional risk being further down in the capital stack.

It's also not just about adding an additional spread, but running sensitivities (cap rates) on the asset to see if and when you can get paid back (as the senior lender gets paid first). There are other levers you can pull as well (especially if you're investing preferred equity)

  • Intern in RE - Other

What are these other levers you can pull (mezz and preff)?

  • Intern in IB - Gen

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