Financing secured by a pledge of the equity in the property owner, not the property itself, sitting between the mortgage and the sponsor's equity.
The longer version
Mezzanine debt is subordinate financing secured by a pledge of the equity interests in the entity that owns the property, rather than by a lien on the property itself. It sits between the senior mortgage and the sponsor's equity in the capital stack, which is where the name comes from.
The structure determines how it works in default. Because the collateral is the ownership interest, a mezzanine lender forecloses through a sale of that interest under Article 9 of the Uniform Commercial Code, which is typically far faster than a real property foreclosure. The winning bidder steps into ownership of the borrower entity, subject to the senior loan.
That is why the intercreditor agreement with the senior lender carries so much weight. It sets the mezzanine lender's rights to cure senior defaults, to purchase the senior loan, the conditions a buyer of the equity must meet, and what each lender may do without the other's consent.
Mezzanine debt is priced well above senior debt because it absorbs losses first after equity. It is related to, and often confused with, preferred equity, which offers a similar position through an ownership stake rather than a loan, with different remedies.
Common questions
- What is mezzanine debt?
- Subordinate financing secured by a pledge of the ownership interests in the property-owning entity rather than by a mortgage. It sits between senior debt and equity in the capital stack and carries a higher rate to reflect that risk.
- How does mezzanine debt work?
- The mezzanine lender lends to the parent of the property owner and takes a pledge of its equity. On default it forecloses on that equity through a UCC sale, taking ownership of the borrower entity subject to the senior loan, under the terms of an intercreditor agreement.
- What is the difference between mezzanine debt and a second mortgage?
- A second mortgage is a lien on the property. Mezzanine debt is secured by the ownership interests in the entity that owns the property. Many senior lenders prohibit second mortgages but permit mezzanine financing under an intercreditor agreement.
- What is the difference between mezzanine debt and preferred equity?
- Mezzanine debt is a loan with a pledge of equity as collateral. Preferred equity is an ownership stake with priority returns. They occupy a similar position, but remedies differ: a mezzanine lender forecloses, while a preferred equity investor typically exercises control rights under the operating agreement.
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