Using Mezzanine Financing for Property Acquisitions

by / Friday, 05 January 2018 / Published in Financing Blog

Lenders are stricter than ever these days, and for good reason. With the financial crisis that hit in 2008, many banks had to deal with borrowers simply walking away from their properties. It wasn’t easy for lenders to deal with the loss of revenue, as most weren’t prepared for the sheer number of homes that were abandoned due to job loss or business bankruptcies.

Although a lender may be willing to offer a loan for the partial amount needed for a purchase, an investor without capital won’t be able to close on the deal until he or she comes up with the difference. This is where mezzanine financing comes into play. This type of capital can be rounded up via an agreement that is basically free of collateral, at least in the traditional sense. Instead of using assets to back-up the loan, the financier commonly requests an ownership interest in the property. This gives the mezzanine lender the peace of mind that, in case of default, the asset can be sold with a portion of the money going back to the financier. Another common arrangement involves the cash flow note. This is an agreement that if needed, provides the lender with the needed cash flow and a percentage of the property sale earnings.

Foreclosure works a bit differently when mezzanine financing is used. Mezzanine loans are more like a partnership agreement, meaning most decisions will require input by the financier. In the case of default, the mezzanine lender doesn’t foreclose on the property itself; rather they seize the equity interests, often gaining the upper hand on decisions going forward.

An intercreditor agreement is key to securing mezzanine financing and working out the details as to who owns what stake in the property. They can be hard to negotiate on an existing loan, as many mortgage lenders do not want to complicate the agreement they’ve already established with the real estate owner. Some lenders welcome the participation of mezzanine providers as they help pay for important costs that otherwise would need to be covered with a bigger loan or much more cash. If the provider is a reputable one, the additional backing can be nice to have, especially in cases of default.

As with any venture, all participants must count the cost of buying into an investment. Mezzanine financing, as is true with other products is not a risk-free arrangement. But it provides a creative way for real estate investors to keep cash on hand while closing on a deal that might disappear if they don’t jump on the opportunity in time.