by A. Heinrich
Mezzanine loans have become a common alternative to conventional subordinate financing when the terms of a superior (first position) loan prohibit the placement of junior liens on the subject property. The reason a mezzanine loan remains possible under such circumstances is that a mezzanine loan is not secured by a trust deed on the property, but by stock in the entity that owns the property. If a conventional subordinate loan is in default, the lender cannot take ownership of the property through foreclosure, since the claim against title represented by the superior lien would have to be satisfied before the subordinate lender could take action. If a mezzanine loan is in default and the proper UCC foreclosure is carried out, the lender essentially takes majority ownership on the holding entity, and therefore also controls the property. It can then proceed, for example, to sell the property. The superior lien must still be serviced and paid off if the property is sold, but the mezzanine arrangement gives the lender more flexibility in negative circumstances than it would have with a conventional subordinate loan.
Mezzanine loans present certain complications to the origination process, including restrictions on the structure of the holding company and typically cumbersome paperwork. However there are advantages for both the lender and the borrower: for the lender, in case of default the foreclosure process is relatively streamlined; and the borrower is able to leverage the property to an extent otherwise impossible: 90% CLTV is entirely typical, and some lenders may go up to 95%.
A typical mezzanine loan might be provided by a bank or conduit that is also providing the superior financing for the property, with a term of 3 years and the lender's return being composed of a combination of front- and back-end fees (of perhaps 1% each) plus the 60-day LIBOR rate plus 4% (currently about 8%). Alternately, a hard money lender may offer a mezzanine loan with a similar term, but with a 15% interest rate and higher fees.