Mezzanine loans are a unique type of commercial real estate financing. The practice is difficult to define in layman’s terms. This article will attempt to clarify what a mezzanine loan is, why investors like mezzanine loans and how borrowers could benefit from this type of lending.
Online searches yield a variety of esoteric definitions for Mezzanine loans. The arrangement involves a borrower paying a fixed interest rate and on additional percentage of future income to a lender. Mezzanine loans blur the lines between debt and equity investment making them somewhat difficult to understand.
Often such lenders get a share of ownership in a borrowers company or a fixed amount of the company’s future profits. In a typical mortgage arrangement a corporation pays its principal lender, before paying its investors and shareholders. With a mezzanine loan in the mix the borrower pays the principal mortgage, the mezzanine lender and then the shareholders. This type of lending bridges the gap between a company’s existing loans and its outstanding equity. This helps companies who are unable to take out additional loans or who do not have sufficient collateral. Mezzanine loans are particularly beneficial for companies with a strong cash flow, or established businesses that need a large amount of financing in order to expand. However this type of lending considered risky. Interest rates on mezzanine loans can range from 12-20 percent.
Mezzanine lenders get very specific and attractive benefits from these loans. Mezzanine lenders often get a share of ownership or equity in the borrowers business. Should the borrowers company succeed, these shares can offer returns to a mezzanine lender far above the initial loan amount. The high interest charged on mezzanine loans offers higher returns to lenders far above traditional loans. Mezzanine lending offers returns similar to equity investment, however the returns are often steadier in comparison. Mezzanine borrowers are usually contractually obligated to make interest payments. Equity investors often don’t get similar guarantees.
Considering the expense why would a borrower use a mezzanine loan as a method of commercial real estate financing?
Mezzanine loans give borrowers the opportunity to borrow a far larger amount than they would be able to through a traditional loan. Borrowers could potentially leverage 3 to 4 times their current cash flow with a mezzanine loan. Another advantage for borrowers is that interest payments on outstanding loans are tax deductible. The higher interest rates involved with this type of lending means a higher tax deduction for borrowers. Above all mezzanine loans are far more flexible than traditional loans. These lenders often work with borrowers based on their current cash flow, with some even giving borrowers a “payable in kind,” interest option. This option gives borrowers who are unable to keep up with current interest payments the option to roll these payments into the principal of the loan and defer interest payments to a later date.
Above all mezzanine loans are a better type of commercial real estate financing when compared with equity lending.
Borrowing against equity is notoriously expensive, usually far more expensive than a Mezzanine loan. Mezzanine lenders often own shares of a borrowers company, but typically act as passive partners. Borrowing against a company’s equity usually dilutes a business owner’s ability to retain direct control over their operations. Mezzanine lending gives borrowers the opportunity to expand without directly losing ownership in their business. Businesses prohibited from taking out second mortgages will usually turn to mezzanine lending, as it usually preferable to selling shares of ownership or seeking out new investors.
Level 4 Funding LLC Private Hard Money Lender
Arizona Tel: (623) 582-4444
Texas Tel: (512) 516-1177
Dennis@level4funding.com NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave |Austin | Texas | 78701
About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 42 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.