Commercial Mortgage Quick Reference Guide
Mezzanine loans have become a popular form of secondary, or subordinate financing in today's commercial real estate market. Although mezzanine loans, in the case of commercial mortgages, are not considered a traditional means of finance, their utility is undeniable, and for the right investors (both borrower and lender), mezzanine loans are an invaluable tool.
Mezzanine loans are most often used as a finance instrument to reduce the equity requirement of the borrower or property owner. Traditionally they sit in the second lien position and are a hybrid of both debt and equity. This means increased return for the lender, obviously due to the increased risk, of being in second position and reducing the borrower's "skin in the game."
In most cases the equity component only kicks in, in the case of borrower default (and, in most cases, the rate on a mezzanine loan is a good bit higher than that of the first lien). Investors making mezzanine loans may look for 20%-40% returns and more. Because of this, for a borrower, these loans only make sense in very particular situations, ideally where there is a substantial "value-add" opportunity in the project in question.