Mezzanine Loans Are More Expensive Than Mortgage Debt But They Are Much Cheaper Than Equity
This is another blog article that was written in late 2005, long before the Great Recession. Since the financial crisis started, mezzanine financing has declined by 85%; but it has not disappeared. The pricing of mezzanine loans has surely changed since late 2005, but this article should give you a starting point.
There are two main types of mezzanine loans - mezzanine loans on standing property and mezzanine loans on construction projects. We shall use the terms standing mezz and construction mezz.
Let's suppose an investor bought an office building 8 years ago for $10 million, and the building is now worth $18 million. He originally obtained a $7.5 million permanent loan from a CMBS lender that is paid down to $7 million. Therefore he owes just $7 million on an $18 million property, and he wants to pull out some cash to buy another building.
CMBS lenders do not permit second mortgages, and their prepayment penalties are ghastly. Therefore the investor will need to get a mezzanine loan to pull out his equity. Today mezzanine lenders are very agressive, so he should be able to easily obtain a standing mezz loan of $7.4 million (80% LTV).
What would this loan cost him? He has two options. One option would be to get a floating rate, standing mezz loan. The other option would be a fixed rate loan.
A floating rate deal would probably cost him one-month LIBOR plus 400 to 500 basis points (bps). Lenders sometimes use the expression, "400 to 500 bips over". In structured finance, one-month LIBOR is so common that lenders don't even have to make reference to the name of the index. Today one-month LIBOR is around 4.4%, so the cost of his loan would be 8.4% to 9.4%.
The typical loan fee would be one point, plus maybe an exit fee of one point.
The term of the standing mezz loan would be coterminous with the first mortgage; i.e., they would mature on the same date. Since the original CMBS loan had a term of ten years, and since the CMBS loan was originated eight years ago, the standing mezz loan would have a term of two years.
Standing mezz loans typically have a term of one to three years, but extention options are often available. Some mezzanine lenders are even willing to go out five to ten years.
In our earlier example, the total debt stack on the office building was 80% loan-to-value. The debt stack includes all of the mortgages, mezzanine loans, and preferred equity investments directly or indirectly secured by the property. Did you know on some very large commercial projects that there will be a first mortgage piece, a senior mezz piece, a junior mezz piece, and a preferred equity piece? That pie is sliced and diced every which way from Sunday.
If a new buyer wanted to buy the office building and assume the $7 million first mortgage loan, he might want a mezzanine loan up to 90% of the purchase price. This way he would only have to put 10% down.
A mezzanine loan of 90% loan-to-value is more risky than one that is 80% LTV. Mezzanine lenders will often use the term loan-to-cost here because appraisals are mistrusted and the building is actually costing the buyer $18 million. A mezzanine loan of 90% LTC might cost 500 to 700 bips over. In this case the cost to the buyer would be 9.4% to 11.4%.
Fixed rate standing mezz deals are typically priced at 450 to 550 basis points over ten-year Treasuries. Ten year Treasuries today are around 4.5%, so fixed rate mezzanine loans up to 85% LTV might cost the borrower 9% to 10% interest. If a buyer needed 90% LTC financing, a fixed rate mezzanine loan might cost 550 to 750 bips over 10-year Treasuries, or 10% to 12% interest.
Construction mezz is typically priced on a floating rate basis with some sort of profit participation. The developer almost always needs at least 90% LTC financing. Therefore a typical deal might be priced at 600 to 700 bips over with a 10% to 25% participation. Since one-month LIBOR is 4.4%, the interest rate might be around 10.4% to 11.4%, plus the profit participation.
Sometimes mezzanine lenders may even go up to 93% to 95% of cost, but these loans are so risky that they are almost joint ventures. As a result, they are very costly. The developer will pay at least 11% to 13% interest plus up to 50% of the profits.
Equity investments from partners and merchant bankers usually cost in the range 18% to 30% annually; therefore in most cases mezzanine debt is much cheaper than equity.
You can apply to scores of mezzanine lenders on C-Loans.com.
Bloomberg's statistics were based on closed sales of commercial real estate; but what about the 35% of all commercial properties that are sitting there with no tenant and no buyer? These older commercial buildings definitely have not appreciated.
The top 40% of all commercial real estate that is modern and well-located enough to attract and keep tenants is appreciating. With ten-year Treasuries yielding under 4.5%, investors are desperate for yield. They are therefore bidding prime commercial real estate sharply up in value.
There is a price, however, at which every commercial property can be sold. It's the price where the commercial property finally clears the market. "Clearing the market" is a price so low that a buyer can finally be found.
To see a street level picture of the subject property, look at the column to the left of the map. If the property is located in a major city, you will often see a street-level picture of the property. (By the way, never trust Google to point you to the exact building because the addresses are OFTEN wrong.) To see up and down the street, to get a feel for the neighborhood, click on the "More" hyperlink directly below the street-level picture of the property. Then click on the choice, "Street View".
Better yet, the map was a satellite view of the land. By moving the roller on my mouse, I was able to look closer and closer at the land. What I found was interesting. The land was right on a major thoroughfare. Sewer, water, and power was already available to the site. Most of the surrounding land was already improved. All of the surrounding buildings were modern and attractive, and the area looked reasonably affluent. Now I don't know if we are going to make a land loan during the Great Recession, but its fair to say that because the broker provided a link to a satellite view of the property, this land loan might actually have a chance.
area of a Rust Belt city, and it was actually in reasonable shape. How could you go wrong risking $300,000 loan on a building that would cost $4 million to replace? The answer will trouble you:
personally flew out to Denver and paid Jay Rollins oodles of money, just to sit down with me for a single day and explain advanced commercial real estate finance. It was worth every penny. Jay Rollins is one those big-brains who is able to take a complicated subject and reduce it to layman's terms.
