Glossary
Mezzanine Debt
Mezzanine debt is subordinated financing that sits between senior debt and equity in a capital structure. It is repaid after senior lenders but before equity holders, so it carries higher interest rates and often includes features such as paid-in-kind interest or warrants. It increases total leverage while limiting the sponsor's equity requirement.
Formula
Example
A property is worth $50,000,000. A senior lender provides 60%, or $30,000,000, at 6%. A mezzanine lender provides another $7,500,000 at 12%, bringing combined LTV to 75%. Equity covers the remaining $12,500,000. The blended cost of debt is ($1,800,000 + $900,000) / $37,500,000 = 7.2%. The mezzanine lender's position is exposed between 60% and 75% of the property's value.
How it is used in underwriting
Mezzanine debt is used in real estate, leveraged buyouts and growth financings when a sponsor wants more leverage than senior lenders will provide. In real estate, mezzanine loans are usually secured by a pledge of the ownership interests in the property-owning entity rather than a mortgage, and an intercreditor agreement governs the relationship with the senior lender. In corporate finance, mezzanine notes are typically unsecured or second lien, with higher coupons and sometimes equity warrants. Underwriters evaluate the mezzanine lender's attachment and detachment points, the cushion of equity beneath it, and the path to repayment.
From the borrower's view, mezzanine debt is cheaper than equity but more expensive than senior debt, and it adds fixed obligations that raise breakeven levels. From the lender's view, the main risks are thin equity cushions and limited control if the senior lender enforces. Key terms include cure rights, purchase options on the senior loan and foreclosure on the pledged equity, which can be faster than a mortgage foreclosure. Mezzanine debt is distinct from preferred equity: both sit in similar positions, but mezzanine is a loan with default remedies, while preferred equity is an ownership interest with negotiated rights.
Typical benchmarks
Mezzanine financing commonly fills the capital stack from around 60% to 65% up to roughly 75% to 85% of value, priced well above senior debt, though terms vary widely by market and asset.
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Frequently asked questions
What is the difference between mezzanine debt and senior debt?
Senior debt has first claim on the collateral and cash flow and carries the lowest rate. Mezzanine debt is repaid only after senior debt, has less protection in a default and therefore charges a higher rate. Mezzanine lenders often rely on a pledge of ownership interests rather than a direct mortgage.
Is mezzanine debt the same as preferred equity?
No. Mezzanine debt is a loan with a fixed repayment obligation and default remedies, usually including foreclosure on pledged ownership interests. Preferred equity is an ownership stake with a priority return and negotiated control rights. They can occupy similar positions in the capital stack but have different legal and tax treatment.
Why would a borrower use mezzanine debt?
Mezzanine debt lets a borrower increase leverage beyond what senior lenders will provide, reducing the equity needed and potentially raising equity returns. It is often cheaper than raising more common equity, though more expensive than senior debt. It also adds risk because more fixed payments must be met before equity receives anything.
Related terms
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