The Waterfall 02: Mezzanine Piece

A fundamental understanding of one of the most widely misused and misunderstood of the capital stack – Mezzanine financing.

Hi again in this next video in this five minute fundamentals mini-series we’re going to talk about one of the most widely misused and misunderstood parts of the capital stack called mezzanine financing this is an important part of the capital structure as it allows you or your borrowers or investors the ability to close the gap on the funds they need between the

Loan the debt and the acquisition price now in this video i will also demystify the concept of a second mortgage and commercial real estate so you’ll want to pay close attention to this video and perhaps watch it several times over and over again in this business the paydays are big but it’s all about what we call the intellectual capital so you have to be able

To structure these deals for everybody’s benefit once you have that then the money will certainly follow let’s get started welcome back welcome to part two and of our installment talking about commercial real estate capital structure these are the things that you need to know about alright in the first video we talked about senior debt senior loans the first trust

Deed lender we talked about the remedies that they had but we came across a little problem is that well if the lift the conduit lenders or if a life company or some lenders coming up only at 65% and you want to buy a piece of property for $1,000,000 what are you going to do well you’d have to come to the table with a 45 percent down payment now do you really

Think that that happens in the world of commercial real estate well depending on the capital markets and how they work yes and no so what we have here is we’re going to talk about the next step up and what we call the waterfall which is the mezzanine piece the mezzanine financing layer and this is something that a lot of people love to talk about but a lot of

Them don’t have any idea what it what it actually means mezzanine is basically providing the closing the gaps the financing the close the gap for you to acquire a piece of real estate and that’s usually done for this with another lender who is not a life company but usually more of an opportunity stick lender and this is important here one thing though that we

Talk about before we get into what we’re talking about here with the remedies and the preference of payments is that i have to remind you that these entities these properties are held in entities called special purpose entities and this is something we probably all know about but there’s not a single commercial lender up there that is not going to want to offer

A loan to a property that’s not going to be held in a special-purpose entity today that entity du jour is the limited liability company and so we talk about that and the reason why we do that is because it has to do with the remedies for a lot of these financial products these structured products and the capital structure that are being offered today let’s talk

About a couple things here before we go any further attributes mezzanine financing what it does is it fills in the gap a lot of mezzanine lenders depending on the markets will go up to 80 85 % i’ve actually seen them go as high as 90 during the really strong market regardless of what you might have heard we’re going to talk about second mortgages second mortgages

Is usually a myth and the reason for that is because sometimes in the eyes of a bankruptcy court should there be some problems the bankruptcy judge will see both the first and the second lenders as being both equal secured lenders so the last thing that a secured lender wants to see has another secured lender there who they might have to share the beans with

Later on due to the fact of a judge making a motion to say hey both of these guys are split even steven so you’ve seen some interesting things happen in bankruptcy court and that’s really why a lot of these products came into being is because they always structure with what can happen in the worst case scenario first and then back into it as far as the collateral

People are wondering what the collateral is it’s not a second mortgage so you’re unsecured it’s secured by the assignment of partnership interests what is that basically that means that the mezzanine lender can step in to the shoes of the borrower and take control of the entire asset like taking control of the llc they become the general partner or the managing

Member the project itself and they’re able to remedy the situation that way by replacing management preference of payment well of course first time the money the floodwaters come in the senior loan is going to be paid first and then the mezzanine will be paid second okay you don’t want to pay if you don’t pay the first loan first guess what happens he can enforce

Foreclosure he can foreclose so it goes scene it alone then mezzanine remedies this is very important here so what happens if something goes wrong and the meds lender has to protect itself what are the remedies for a mezzanine financing piece very simple there’s one of two ways and these ways are explained in what’s called the inter creditor agreements then the

Inter creditor agreement and usually that this is the mezzanine is originated at the science same time as a senior debt as the first trust deed usually will happen is that there is something called in the inter creditor agreement the preference of repayment now a lot of these mezzanine loans are opportunistic lenders and a huge gargantuan companies like metlife

They’re not life companies they’re not huge wall street investment banks although some of them are what happens is that you have to put the language into the writing and the inter creditor agreement is sort of like a prenuptial agreement meaning what happens when things go bad and there’s two ways to do it they can either pay off the entire senior loan and that’s

Very very cost prohibitive to do so figure if this guy has a he doesn’t have the deep pockets to pay off metlife over here you’re gonna have some problems so that might not be able to happen the second remedy over here would be to assume the senior loan and just make payments on the senior loan on the first trust deed sort of like free real estate investors in

Residential if you’re familiar with subject two it’s the same thing only of taking title over sort of speak in the name of the llc so that concludes the basics of mezzanine financing and we’re going to continue in this series now where we’re talking about capital structure and the next one up the totem pole that’s going to be preferred equity

Transcribed from video
The Waterfall 02: Mezzanine Piece By The Commercial Investor