Mezzanine debt — "mezz" — is one of the most misunderstood instruments in commercial real estate finance because it looks like debt but acts partly like equity. It exists to bridge the gap between what senior lenders will fund (typically 65–75% of cost) and the amount of common equity the sponsor wants to raise.
Where mezz sits in the capital stack
In order of priority from lowest cost to highest cost, the capital stack on a typical value-add deal looks like:
- Senior debt (mortgage) — 60–75% of total cost, 7–10% rate
- Mezzanine debt — 5–15% of total cost, 11–15% rate
- Preferred equity — 0–10% of total cost, 11–14% preferred return
- Common equity (sponsor + LPs) — 15–30% of total cost, 18–25%+ IRR target
What collateralizes mezz
Mezz is NOT secured by a mortgage on the property. The senior lender holds that lien and won't allow a second mortgage. Mezz is instead secured by a pledge of the equity interests in the LLC or LP that owns the property. If the borrower defaults, the mezz lender forecloses on the equity interests under the UCC and takes ownership of the entity (which then owns the property, subject to the senior loan).
This collateral structure is the entire point: it lets a mezz lender lend behind a senior lender without violating the senior loan's restrictions on second mortgages.
Typical mezz terms
- Loan size: $1M to $50M+ (the deal usually has to be large enough to justify the legal structure)
- Term: 2–5 years, coterminous with the senior loan
- Rate: 11–15% (some pay-in-kind portion common — accrues to balance rather than cash-paid)
- Structure: interest-only with balloon at maturity, often with extensions
- Prepayment: usually a make-whole period (12–24 months) then declining
- Combined LTC with senior: typically up to 80–90%
- Required intercreditor agreement with the senior lender
When sponsors use mezz
- Value-add multifamily: senior at 70% LTC, mezz at 10%, sponsor and LPs at 20% equity
- Hotel acquisition or repositioning
- Ground-up development where construction LTC caps at 75% and the sponsor wants to limit equity
- Recap and partner buyouts (an existing partner cashes out via mezz proceeds)
- Bridge-to-sale where total leverage justifies the higher cost in exchange for less equity dilution
Mezz vs. preferred equity
Mezz is debt — fixed coupon, scheduled maturity, foreclosure remedy. Preferred equity is equity with a fixed preferred return; the holder has no foreclosure right but typically has step-in rights if the sponsor underperforms.
Practical differences: mezz interest is tax-deductible to the borrowing entity, preferred return is not. Senior lenders generally prefer pref equity behind them because it doesn't have a UCC foreclosure remedy. Pricing is similar — both run 11–14% — but mezz is structurally tougher and pref is more flexible.