Construction Mezz

20-IRR's picture
Rank: Senior Monkey | 68

I have an interview next week with a company that does construction mezz. I am curious if anyone is in this industry. I would like to know how you underwrite a deal? Do you just take the developers model and tweak their inputs and assumptions? Do you have your own proprietary model? I appreciate anyone who can shed some light on the underwriting process. Thanks.

Comments (9)

Jun 23, 2015

So is that technically distressed? Do they do bridge? Construction would only need a mezz when things run awry, correct?

Interesting subject

Jun 23, 2015

I don't know about bridging. I think they basically fill the stack between equity and senior construction. For example, if senior will only do 55% LTC and sponsor has 20% equity, mezz will come in for other 25%.

Jun 26, 2015

20-IRR is right. if you have $100M Development Budget and the Senior Lender will only finance 65% LTC, but you want 75%, you will fill the gap with Mezz, assuming the Lender allows it. In the event they don't, you can raise Preferred Equity instead. More or less the same, but different rights in the case of default.

Construction Mezz Rates that were seeing are in the 9-12% range usually above 10%.

In regards to modeling the deal, you're going to draw on equity first, then Mezz, then draw on the construction loan. I don't work for a Mezz shop, but assume you'd use the Developer's draw schedule and figure out if your economics work. I.e. do you get the money out the door fast enough to hit your needed returns and when you'd get paid back. I'm guessing you'd tweak their assumptions to see the downside in the event they don't lease-up in time or construction takes longer, for example, but basically solving backward to see if you get your IRR.

Not really on topic of modeling, but with Mezz Lenders, you'll see them bidding to win the full Loan, then sell off the Senior piece. I.e. they'd submit a term sheet for full 75% LTC to the Sponsor, or try and push the stack higher to get the deal and then sell off the Senior debt.

Jun 26, 2015

What senior construction rates are people seeing? 7% at 70 LTV? 20 mm deal.

Jun 26, 2015

We haven't looked at deals that small, but imagine that's safe at the high a leverage. up to 55%-65% you could probably be in the 4-5's.

Jun 26, 2015

I do some mezz/pref equity deals. We just went in on a new development deal. The developer had a 75% LTC construction loan from the senior lender at L +350ish. We filled the gap to 100% for a 19% preferred return with a term of construction period + 6 months. We were very comfortable with the developer and the asset they were developing. There are a lot of different ways to approach Mezz/Pref Equity, this is just one example.

Jun 26, 2015

So on 25% of the loan/construction cost, the sponsor was essentially paying 19% interest for the mezz? I know it takes the sponsor out of the risk component completely, but isn't 19%....high? @picklemonkey

Jun 27, 2015

For an interview, I would note that there are very specific considerations to mezz deals. As you are subordinated to senior you need to be very comfortable with the sponsor and project, understand your rights (a lot of fairly complex deal specific legal work) and you can often get security over other assets separate to the project from the sponsor that is not subordinated to senior. For the legal stuff, read some papers on rights of mezz and pref, can't understate the importance of knowing this stuff.

In terms of underwriting, as others have mentioned you do it from a debt perspective and an equity perspective, to make sure there is enough capacity for things to go a bit wrong and still have senior paid out (so you get access to the security). You want to see what IRR the sponsor is getting and then stress test the hell out of it.

Hope that helps, good luck. It's an exciting part of RE to work in.

Jun 28, 2015