Subordinated Debt is defined as a loan with a lower repayment of priority to any other outstanding debt encumbering a property. Often times, a property may be encumbered by multiple loans with legal priority determining how these loans are classified including secured (e.g., first mortgage, second mortgage) and unsecured (e.g., mezzanine) debt. Such loans are dependent upon the senior debt for classification as to temporary or permanent term as subordinate debt must be retired on or before the maturity date of senior debt.
Jude verse 1990 real-estate capital basics subordinate loans subordinated debt is defined as a loan with a lower repayment of priority to any other outstanding debt encumbering a property often times a property may be encumbered by multiple loans with legal priority determining how these loans are classified including secured for example first mortgage second mortgage
And unsecured for example mezzanine debt such loans are dependent upon the senior debt for classification as to temporary or permanent term as subordinate debt must be retired on or before the maturity date of senior debt leveraging any lucrative senior financing subordinate debt provides additional funds for a multitude of reasons including funding further physical
Improvements tax free loan proceeds increased leverage yields and replacement of more costly equity subordinated debt instruments are attractive investment vehicles because higher yields are exchanged for assumed subordinate lien positions in both principal and interest funding sources include banks credit companies thrifts wall street securitizations private
Capital and to a lesser extent life insurance companies and pension funds the most popular support net debt vehicles include second mortgages mezzanine debt and wraparound mortgages second mortgage the second mortgage is the simplest and most common form of subordinate financing also known as a tudor mortgage this form of funding is structured as a recorded lien
Encumbering real property and obviously is subordinate to a senior lien position in your instances with larger and more complicated financings a second mortgage can also be a third lien or lower lead structured for repayment within the term of the senior debt second mortgages use various payment formats including fixed-rate variable rate participating convertible
And preferred equity mezzanine debt practical terms mezzanine debt is mez nearly identical to a second mortgage except for lien positioning mezzanine debt is unrecorded debt instead is an equity obligation the mez node holder has a principal position in the ownership structure as debt is often structured as preferred equity messed notes are especially very popular
Lien formats in securitized loans which usually prohibit secondary liens in the event of default the mez letter assumes the priory equity ownership role and may choose to cure the first lien as a principal protection mechanism since the loans are unrecorded against the property higher yields are required to compensate for repayment risk dynamics wraparound mortgage
The wraparound mortgage is lesser-known subordinate debt program that was popular during the 1980s when extremely high interest rates were commonplace wraparound mortgages were popular with borrowers having attractive first mortgages in place at below market rates which were unprofitable to disturb also known as a blanket mortgage the wraparound mortgage is a
Financing technique wrapping a favorable lower rate first mortgage with additional funding proceeds to form a new loan the wraparound mortgage combines the existing loan balance with freshly generated proceeds into a new loan with a revised interest rate blending the original rate and a yield premium for the added funds the rapp lender structures the revised loan
And a below market interest rate on the face amount of the wrapped loan priced below current market rate on a new first mortgage taking advantage of the undisturbed and competitively priced first mortgage remaining in place while wraparound mortgages are similar to other subordinate debt instruments for tapping into additional funds a number of features distinguish
This form of financing from typical subordinate debt the total proceeds both existing and newly advanced are shown as the face amount in all loan documentation a special agreement between senior and wrap lender covers debt service payment responsibilities and discusses cure provisions in the event of default a promissory note in a lien is filed like any other form
Of secured debt as well wraparound mortgages are still popular for a variety of reasons when interest rates are high borrowers will try to protect properties encumbered by below market senior debt funding sources are dias leaguer to rap a first mortgage loan at higher yields premiums and other terms that take advantage of the underlying debt negotiating a wraparound
Mortgage favorable to all parties requires understanding the key issues of the funding structure including first mortgage restrictions prepayment penalties the wraparound coupon rate and overall yield as well as how much additional funds to advance numerous wraparound mortgage vehicles exist including the most popular shown below which are differentiated by timeline
Equal term wraparound mortgage when the term of the wraparound mortgage and underlying senior debt have the same term the result is an equal term wraparound mortgage the equal term wraparound mortgage is the most popular program offering additional funds while minimizing principal repayment overhang risk extended term wraparound mortgage when the loan term of the
Additional wraparound proceeds fund succeeds the senior debt term the lender is providing an extended term wraparound mortgage generally speaking when the wraparound mortgage has a longer term than the underlying debt the borrower enjoys reduced mortgage payments in the lender a corresponding lower yield most important of all the extended term wraparound mortgage
Is riskier to the funding source because the additional funds are exposed over a longer period of time than the primary mortgage creating a greater refinance risk reduced term wraparound mortgage the opposite of an extended term wrap loan the reduced to wraparound mortgage is prepaid sooner than the underlying senior debt since the term is shorter than the senior
Debt the payments and amortization schedule will typically lead to higher debt service payments you
Transcribed from video
1990 06, Real Estate Capital Basics – Subordinate Loans By RECI
