Mezzanine Loans Are a Way to Achieve Extraordinary Leverage on Huge Commercial Projects
This blog article was first written in late 2005, long before the start of the Great Recession. Mezzanine lending has not completely disappeared, but the volume of new mezzanine loans has declined by 85% since then. Nevertheless, this blog article was worth saving, as I rearrange articles on my blog.
Mezzanine loans are similar to second mortgages, except a mezzanine loan is secured by the stock of the company that owns the property, as opposed to the real estate.
If the company (usually a LLC) fails to make the payments, the mezzanine lender can foreclose on the stock in a matter of a few weeks, as opposed to the 18 months it often takes to foreclose a mortgage in many states. If you own the company that owns the property, you control the property.
Our own hard money company once had to foreclose a mortgage in New York, and it took almost two years. Yikes! In contrast, a mezzanine loan is secured by the stock of a company, which is personal property and can be seized much faster.
Mezzanine loans are also fairly big. It is hard too find a mezzanine lender who will slug through all of the required paperwork for a loan of less than $2 million. It is occasionally possible to obtain mezzanine loans as small as $1 million.
In addition, mezzanine lenders typically want big projects. If the property you are trying to finance is not worth close to $10 million, you may have a hard time attracting the interest of any mezzanine lenders.
There are three typical uses for a mezzanine loan. Suppose the owner of a $10 million shopping center has a $5 million first mortgage from a conduit. The owner wants to pull out some equity, but he cannot simply refinance the shopping center because the first mortgage has either a lock-out clause or a huge defeasance prepayment penalty. In this instance, he could probably obtain a $2.5 million mezzanine loan to free up some cash.
Suppose an experienced office building investor wanted to buy a partially-vacant office building in a fine location. Once again, assume that the purchase price is $10 million (when the office building is still partially-vacant) and that the conduit first mortgage is $5 million.
This may surprise you, but the right mezzanine lender might be willing to lend a whopping $4 million! But isn't that 90% loan-to-value? Yes, but when the vacant space is rented - remember, our buyer is a pro - the property will increase to $12 million in value. Suddenly the mezzanine lender is back to 75% loan-to-value and his rationale is obvious. This kind of deal is called a value-added deal.
The third and final use of mezzanine loans is for new construction. Suppose a developer wanted to build a 400 room hotel across the street from Disneyland. Hotels today are out of favor, and a commercial construction lender might only be willing to make a loan of 60% loan-to-cost. If the total cost was $20 million, the developer would ordinarily have to come up with 40% of $20 million or $8 million. That's a lot of dough.
A $3 million mezzanine loan solves the developer's problem. The commercial construction lender would advance $12 million, the mezzanine lender would make a $3 million mezzanine loan, and the developer would "only" have to come up with $5 million.
There are about 150 mezzanine lenders active in the country today, and you can apply to most of them by just clicking here.