All, recently spoke to someone and they mentioned they were getting an uptick of interest adding mezz debt to their deals that might look a bit more attractive than the rising rates of traditional financing alternatives.
What are you seeing in your particular markets/asset classes in regards to the 'potential' increase of mezz debt financing over traditional lending given the increasing interest rates?
The reason why you are seeing a proliferation of additional mezzanine loans is to increase leverage (total borrowed money relative to project costs), not for better pricing.
I lead acquisitions for a ground up multifamily developer and traditional lenders over the past 5-6 quarters have kept tight underwriting standards due to Dodd-Frank and their need to carry a percentage of the loans they issue on their balance sheets. As such, construction debt for new players has been very difficult to obtain as most lenders filled their development allocation buckets with deals from existing relationships. This is what has led to the rise of secondary debt - smart players have stepped in to provide this extra leverage but at a price; high interest rates and equity participation in deals if they fall apart.
Because of these higher standards, most construction loans are being underwritten at 60-65% loan to cost (LTC). Prior to the financial crisis, these same deals would have gotten 80%+ LTC construction financing. Most developers are not well capitalized so in order to do multiple deals with their limited capital most have to leverage up as much as possible.
As others have pointed out, mezzanine debt includes higher pricing since it is typically second (or third, etc. depending on capital structure) in the capital stack behind the first mortgage which makes sense given they have a higher chance of their debt not being paid. The elevated pricing is true - a mezzanine loan that gets you up to 80-85% LTC will cost around 12 to 15% interest. But imagine you're a developer and need to keep your pipeline full - the bank is only giving you 60% LTC, why not take out that 25% mezzanine loan at 12% interest if it allows you to do another deal or two?
Another very important thing people don't realize is that folks take out the expensive mezz for relatively short time frames on opportunistic deals that yield high returns. They're not paying 13% interest for 10 years.
Mezz debt on stabilized trophy deals can be as low as 4% if you're just bridging the gap from 50-65% LTV. Folks also need to keep in mind that slice can be further cut up into smaller pieces (i.e. senior mezz and B-piece), each of which will earn different returns as well (i.e. 6% on the a and 8% on the B). There's a lot of ways to skin the cat, especially if you are creative and know how to use leverage properly.
The most important thing that people also forget is it not even about the rate - it's really about the inter-creditor agreement and the rights the lender will have to screw you in a default scenario as well well as the cures and remedies you will have to protect yourself. You can have the best rate ever, but if the agreement is written such that the lender can literally steal your keys at the first misstep your rate doesn't matter.