Real estate financing options are numerous, and get more advanced when you include mezzanine financing. It is one of the most important types of financing options if you’re a serious investor. If you want to fill the gap between your equity investment and primary loan, mezzanine financing is the best choice.
Mezzanine financing is unsecured debt and preferred stock rolled into one. It is a basic definition of an advanced financial option that can provide almost half of the financing needed for a large project. When you’re looking to dive deep into this mindset, it requires knowing the value of the collateral and how it impacts your spending. There is a lot of freedom allowed when your equity isn’t tied up in a single project. Resources are limited, so using mezzanine financing provides you a lot more spending flexibility. Every individual will have a different capital stack after adding in their specific mezzanine loan contract.
Investors that want to use mezzanine financing should play to their strengths. Equity extraction, new construction, and value-added deals are three of the top projects for mezzanine financing.
There may be other financing options that are more attractive than mezzanine financing. Having extra resources to use is a huge draw when dealing with a large investment. But it can also be a drain on your entire portfolio if you’re not prepared for the consequences. Mezzanine financing has a huge upside, but in some instances, the downsides may make it a secondary choice. Most of these projects are large, costing multiple millions of dollars to just get off the ground. You don’t have to have a large budget to attach mezzanine financing to it. But it helps to play to its strengths since there are more compatible loans available for smaller projects.
Defaulting on any loan is bad news, but is considerably worse if you are dependent on mezzanine financing. Unlike regular loans, a lender can fast track a foreclosure under Article 9 of the Uniform Commercial Code. With a regular loan, it can sometimes take up to a year for foreclosure paperwork to fully materialize. This leaves a lot of wiggle room for the borrower to work out a deal, and possibly reverse the process. Without that year buffer, mezzanine financing becomes a high risk if you don’t follow the contract. That doesn’t make it an all or nothing gamble, but it does put urgency on the borrower to follow through with their dealings.
The type of contract you work out for mezzanine financing is a big deal. Some lenders like to include what’s known as a Payment in Kind toggle. This is a feature that helps out when borrowers can’t make an interest payment. A PIK toggle takes a lot of weight off of the consequences of defaulting on mezzanine financing. Things happen in life, so having this feature should be essential for any contract.
How you manage your capital will determine the usefulness of it in long-term investments. Some investors use mezzanine financing in combination with a primary loan. However you decide to use it, chances are you’ll gain a massive benefit to your project.