Using Mezzanine Loans for Real Estate Finance

Mezzanine loans are an attractive option for real estate projects that require a high level of liquidity, so high that it cannot be secured by one lender. Mezzanine lenders can step in to provide the remaining balance required to finance a project. These lenders offer flexible profit-sharing options that can meet both short and long-term financing goals. Borrowers should be prepared for a lengthy process that will require them to cede part of the control of the project. 

Loan is Secured through Senior Lender

The first step in arranging financing is securing a loan through a traditional senior lender. This is usually a bank, but may also be a dedicated lender or government grant. This portion of the financing is usually secured through some type of collateral such as a business, home or auto loan. The high priority of this loan means it will be paid off first in case of bankruptcy. This allows for the lender to have some degree of assurance through both the high priority and the collateral in order to make this loan less risky. Because it is less risky, the terms and interest rate should remain fairly low.  

Additional Financing Needed is Determined

Once a borrower has secured as much financing as possible through a traditional lender, the borrower then looks at the amount of financing the venture still needs in order to succeed. This is determined through estimated costs and financial projections prepared in a business plan. A business plan is an essential part of moving forward responsibly, and financing preparations should not be overlooked in the business plan. Speaking with an accountant and attorney regarding estimated unforeseen expenses is essential. 

Business Plan is Presented

The business plan and financing secured so far are presented to a number of potential mezzanine lenders. Real estate developers can commonly find financing through hedge funds, mutual funds and private equity groups. The various potential lenders will review the business plan to determine the possibility of receiving a profit. If they feel the project has a high potential chance of success, they will take the risk of providing financing, even without proper collateral in place. They are assuming additional risk because they will have a lower priority than senior lenders should bankruptcy proceedings occur. 

Loan is Finalized

The loan terms for a mezzanine loan tend to be very flexible, but are also very detailed. A lender will want to set forth exact terms for how and when the borrower can make financial decisions. Some mezzanine lenders will look to secure a voting position on the board of directors for the company. Others will restrict how much debt the company can hold and whether the company can seek additional financing in the future. Then, the mezzanine lender and the borrower will agree to terms to turn the debt into equity for the lender. The lender will either receive a profit-share, equity in the form of stock with dividends or even be listed as a joint venture partner on the new real estate development. In any case, a mezzanine lender is more of a business partner than a traditional lending company.