RE Mezzanine Debt

Temujiin's picture
Rank: Gorilla | banana points 612

Can someone give me a rundown on mezz debt?

1) What term will mezz lenders do?
2) Is it always interest only or do they also amortize in some circumstances?
3) Are there ever holdbacks in the loan? Is it always fully funded upfront? What if it is for construction?
4) What total DSCR, LTV, LTC, and DY are mezz lenders typically ok with?

EDIT: 5) Is it typically floating rate or fixed rate? Or is it closer to 50/50 and completely dependent on the deal?

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Comments (37)

Dec 5, 2018

interested as well

Dec 6, 2018

Agency lender offer mezz now, need to be at least 1.05x/80% on whole debt, mezz is full IO

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Dec 6, 2018

Not two term sheets are the same but in my experience...
1) Typical bridge terms (2+1+1 or 3+1+1)
2) Always I/O and they are typically obliged to hold 66% of the loan on their books (opposed to selling into a CLO)
3) Usually a future funding component based on meeting certain debt performance criteria (NOI/DSCR, etc.) or paying additional equity into a reserve.
4) This changes based on market conditions. There seems to be desperate liquidity right now with alot of mezz lenders putting money out at break-even just to deploy capital and develop relationships with borrowers. LTV and LTCs are increasing today while deals are getting done with lower DYs/DSCRs.

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Dec 6, 2018

1) Would you say it is uncommon for the total term, including extensions, to exceed 5 years?
4) I'm guessing you'd be talking about loan metrics similar to LTV (70-80%), LTC (75-85%), DY (<8%), DSCR (1.00x-1.10x). Does this sound about right?

Most Helpful
Dec 6, 2018

As others have mentioned, this is usually all over the map. This is what I have seen in the past year:

1) Depends on the lender but can be anything. Typically it is co-terminus with senior.

2) Usually interest only, especially on bridge deals. If you're putting mezz on a core deal, then it might have some amortization.

3) Also all over the map. Typically, mezz lenders will want to force fund day one. If they have the capability to do future draws (a lot of mezz lenders aren't staffed like construction lenders for frequent draws), then they might agree to future funding.

4) Super broad question, but here's some loose guidance:

  • **LTV/LTC ** <=80%. Once you pass this mark, you're really getting into participating pref equity. I've never seen a deal >85% leverage that's not getting a piece of the pie.
  • DSCR - for multi typically 1.10x+ and 1.20x+ for agency. Commercial deals typically 1.30+
  • DY - usually looking for a 1.0%+ spread over cap rates
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Dec 6, 2018

Thanks for the answer. I've got a couple follow-up questions.

For the DSCR calculation, would that be based on the actual interest rate of the loan, or an underwriting constant that the lender utilizes? Being subordinate to a senior loan that often is floating rate, how would they look at that?

Would a mezz lender really be able to get comfortable with a 6% DY on an asset that is valued at a 5% cap rate?

Dec 7, 2018

Also curious to know about underwriting and sizing. I assume the mezz provider underwrites to a DSCR/total loan amount based on an internal rate/constant (like the senior provider) rather than the actual rate, but that's just my guess.

Dec 6, 2018

Typically mezz guys are more focused on DY, especially for bridge deals. However if they are doing fixed rate, they will usually just schedule everything out and look at the actual DSCR at that point in time (whether I/O or amortizing). They pay particularly close attention to roll years (i.e. if there's a big tenant expiring in year 2, they are going to look at how the coverage holds up and size the deal based on where they might feel protected enough during that event). Varies widely.

If you're talking Freddie/agency type mezz pieces, then they assume a constant and calculate DSCR on both I/O and amortizing, but they constrain usually by amortizing. If it's floating they then calculate the DSCR "at the cap" (i.e. if you have a floater over LIBOR that's capped at 6% max, then they will calc on that as well). Agency guys look at every single metric and typically size based on the most conservative ones.

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Dec 6, 2018

Can someone explain the equity interests mezz lenders have as collateral?

Wouldn't the senior loan provider have priority if things go sour, essentially taking over the building?

How does he mezzanine lender then collect rents?

Dec 6, 2018

It was taught to me that the mezz lender will take control of the building and make payments to the senior lender (almost) as if the sponsor just changed in the senior lender's perspective. But there are other, more experienced people on this forum. Sure they could add more color

Dec 14, 2018

Its explained better below

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Dec 6, 2018

Mezzanine loans are secured by the partnership interest as opposed to the property itself. If things go sour, the mezzanine lender can take control of the entire partnership, essentially becoming the borrower.

For example,
Project total cap is $100MM
Senior piece (Bank 1) is $70MM
Mezz piece (Fund 1) is $15MM
Equity piece (Fund 2) is $15MM

In the event that things go sour, the Mezz piece can take control of the equity piece. Once that happens, capital structure will become (assuming valuation does not change):
Senior piece (Bank 1) is $70MM
Equity piece (Fund 1) is $30MM

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Dec 6, 2018

This is incorrect. Once the mezz forecloses on the equity and essentially becomes the equity/owner of the asset, the equity of the original owner gets wiped out, they do not have 50% membership interests in your example. Now if the asset is sold at > $85MM in your example, the residual will flow to the original equity owners pursuant to the terms of their OA/waterfall structure, since a lender cannot recover more than they loan.

Also bear in mind that a mezz lender is considered an equity investor and thus gets equity like returns because they may be subject to egregious subordination and standstill clauses in the intercreditor agreement that governs the rights between the senior and mezz lender. If the mezz lender is subject to a standstill, then even in an EOD, they cannot do anything and cannot forelcose on their collateral and are essentially held up until the senior is taken out. Also in almost every case before the mezz can step in, if there'a default under the senior they need to cure it or buy out the senior at par to extinguish any defaults then existing under the senior, unless they enter into any type of waiver/forbearance agreement with the senior lender, which is highly unlikely given the mezz lender is not in the business of owning/operating the property.

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Dec 6, 2018

Can someone clarify all of this? I just got more confused.

Dec 7, 2018
CRESEA:

Mezzanine loans are secured by the partnership interest as opposed to the property itself. If things go sour, the mezzanine lender can take control of the entire partnership, essentially becoming the borrower.

For example,
Project total cap is $100MM
Senior piece (Bank 1) is $70MM
Mezz piece (Fund 1) is $15MM
Equity piece (Fund 2) is $15MM

In the event that things go sour, the Mezz piece can take control of the equity piece. Once that happens, capital structure will become (assuming valuation does not change):
Senior piece (Bank 1) is $70MM
Equity piece (Fund 1) is $30MM

Damn, that's smart. A few fellas and I issued a mezz loan a few years ago and the deal went sour but we had no way to take control of the deal from the grossly incompetent principal. Wish I had thought about holding security in the partnership interest. Fuck.

Dec 6, 2018

@zacksc11 I think that you misunderstood my example.

In the example, I was trying to show that the original equity investor gets wiped out in the event of a mezz foreclosure. In most of those cases, the mezzanine partner has the option to take over the equity part of the investment. You are correct in saying that in the real world, the example that I provided above is highly unlikely since the property would probably need to drop below $85MM for that type of foreclosure to happen. Unless of course, there was a unique situation where the cap rate was incredibly low and therefore could not achieve debt service but building values remained high (Edit: there would also have to be almost 100% accrued interest in that scenario).

I disagree with your assessment that mezz lenders are not in the business of owning/operating property. Increasingly, more traditional investment funds have been going into the mezzanine space due to the incredibly low yields seen in the equity markets. The (proforma) premium paid to pref equity investors over mezzanine investors is incredibly low and mezzanine investors are more protected on the downside.

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Dec 6, 2018

I did not misunderstNd your example in your example you indicated the mezzanine and the original partnership would share in equity in ezsenxe the original members would be diluted this is 100% incorrect as the mezzanine takes full control of the equity as their collateral and fully owns the property company and controls the borrower under the senior. This is a critical point that should be made clear which in your example is a.mistake.

Dec 6, 2018

Can a mezz lender with real world experience clarify all of this up?

How does forclosing on a property work and what is the relationship with the senior lender? Who is collecting future rents?

Dec 6, 2018

@zacks11'' Where did I imply that the mezz lender does not take 100% control of the equity?

@yayaa There is an intercreditor agreement that defines the relationship between the two parties. That being said, the senior loan does not necessarily have to be in default for the mezz piece to foreclose. It depends on the loan docs to determine who collects future rents (cash flow sweep provision).

Mar 15, 2019

Unless he edited after you responded his example makes perfect sense. Fund 2 was wiped out of the equation.

Dec 10, 2018

Mezz is tight cause you can lever that bitch up and get equity returns without taking an equity position

Fuckin my way thru nyc one chick at a time

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Dec 15, 2018

Haha. Would love to hear you say this in an interview with a debt fund

Dec 15, 2018

Ya bro can't believe anyone even considers equity

Dec 10, 2018

I was talking about levering internally. The mezz lender could make a 10mil loan at 12% but borrow from a line of credit for 5mil at 4% and use 5mil of his own money for the other half of the loan. His returns will be well above 11%

Fuckin my way thru nyc one chick at a time

Dec 10, 2018

one other key item that makes Mezz different than most other senior debt term sheets is the differentiation between accrued and current interest. Current interest works like your typical interest payment does...there is a all in coupon rate multiplied by the last closing month's outstanding principal, and is paid to the lender during that period. However, accrued interest does exactly that, it accrues. Every term sheet can be different, but from what I've most seen is that the interest is not paid at that current month, but rather is tacked on to the principal and accrues throughout the life of the loan. At the loan maturity, the original principal PLUS this accrued interest is due. Some deals use one or the other, some mezz term sheets use both. Either way it's important to note the actual rate during these accrued interest pieces. Hope this helps, in addition to all else that has been said.

Dec 6, 2018

Does the accrued interest compound normally?

Dec 10, 2018

it's really term sheet by term sheet...but the idea is yes, it accrues and compounds. Whether it's monthly or annually again would depend on the term sheet, but annual is usual. For a deal that wouldnt compound, you essentially book the calculated interest into a separate account to be paid at loan maturity - but it wouldnt be tacked on to the principal for the next period interest calculation

Dec 23, 2018

What are some of the biggest firms doing construction mezz right now ?

Dec 6, 2018

EB5 is very popular for construction mezz non-recourse and single digit returns given the other non-financial returns to the EB5 investor

Dec 6, 2018

That's equity, not mezz debt though. Correct?

Dec 10, 2018

Nah pretty much all EB-5 deals are mezz. Partially because the Chinese investors want income with their investment

Fuckin my way thru nyc one chick at a time

Dec 6, 2018

@Temujin RE" From my understanding based on the more recently funded projects in our market, yes.

@REfuturesee Colony, Brookfield, Blackstone, TPG, PCCP, Madison Realty etc. Lately, there have been a lot of well capitalized Real Estate investment funds/developers who have started lending in the space since returns on mezz loans are not much different than equity returns in the current market and the position is substantially safer