An article calls mezz a second mortgage, another says it isn't

Question

Two things I read that don't sit together. One article described mezzanine debt as basically a second mortgage on commercial property. Another said the mezz lender doesn't get a lien on the building at all, just a pledge of the LLC that owns it. Those can't both be the standard structure, and I'd like to know which one the word actually means before I use it wrong in front of somebody.

Second part, and I suspect the answer is discouraging. I have around $150k I could put toward something like this over the next while. Everything I read talks about $5m pieces. If I wanted exposure to this at my size, what is the realistic route, and what does it cost just to paper one of these loans? I've seen legal fees mentioned but never a number.

Rena Guide · Accepted Answer

Warrant has the definitional part right, so here's the money part.

Documenting one mezz loan is expensive because you're negotiating two agreements at once, the mezz loan and pledge documents plus the intercreditor with the senior lender. On institutional deals people commonly quote $40,000 to $100,000 or more of legal cost per side, and the borrower usually pays both sides' counsel. On smaller club style deals you might see $15,000 to $40,000. Add a title and UCC search, an appraisal the senior often already ordered, and third party reports if the senior's are stale. Those costs don't scale down much, which is exactly why the pieces are large. A $500,000 mezz loan carrying $50,000 of legal cost is a 10 percent fee before any interest, so most lenders won't write below roughly $2m and many start at $5m.

At $150,000 the realistic route is passive. Private debt funds and mezz focused vehicles take limited partner commitments, often with $25,000 to $100,000 minimums, and they do the structuring you can't afford to do alone. Some are open only to accredited investors, and whether you qualify is a definitional question worth confirming before you spend time on it.

One thing to look for in a fund's documents: whether the manager can advance cure payments to the senior lender on your behalf and where that money comes from. A mezz position whose sponsor stops paying is worth what the fund can afford to spend keeping the senior current, and a fund with no reserve capacity is holding a right it can't use.

dmitri_v6 · Answer

The strict meaning is the pledge. A mezzanine loan is secured by a pledge of the equity interests in the property owning entity, and it's governed by an intercreditor agreement with the senior lender. A second mortgage is a junior lien recorded directly against the real property. People use "second mortgage" loosely for anything behind the first, which is where your two articles collide. One practical reason the pledge structure won: recording a junior mortgage can trigger mortgage recording tax in states that levy one, and a UCC filing on membership interests generally doesn't, though that treatment depends on the state and it's a question for local counsel. Foreclosure timelines are the bigger difference. A UCC sale of LLC units can run in weeks where a judicial mortgage foreclosure runs in quarters or years, again depending on the state.

aaron_fitz10 · Answer

The $50k of legal on a $500k loan is the line that finally made the minimums make sense to me. Nobody says that part out loud.

chriswalton8 · Answer

How do these pieces even get found at $150k of scale? Every mezz deal I've read about seems to arrive through a mortgage broker who already knows the senior lender and the sponsor, which means the deals never reach anyone outside that circle. Is the fund route the only door, or do people co-invest alongside a lead who's writing the $5m and needs the last million?

priya_n21 · Answer

If a chunk of the rate accrues instead of paying monthly, does an income investor actually see anything before payoff?

raj_mehta14 · Answer

Where I keep losing the thread is that both instruments get called paper. A note secured by real property and a note secured by LLC units look identical on the cover page, and then the remedy sections live in completely different bodies of law. So the pledge version isn't safer or riskier by nature, it's just faster and lands you holding a company that owes a mortgage rather than holding a building...

marcus_hale41 · Answer

Two searches I'd want before putting money into any of this, fund or direct. One, the UCC filing on the pledged interests, to confirm it was actually filed and in the right place. Two, the borrower entity's operating agreement, to confirm the pledge is permitted without member consent and that the mezz lender's remedies can't be blocked by a minority member. Warrant, you like documents, that second one is the document that always gets skipped, and I mean genuinely skipped rather than glossed.

kevin_lombard · Answer

Marlow's question is the one I'm still stuck on too. If 3 of a 13 percent rate accrues and the exit is three years out, the accrued piece is only real if the property is worth more than the whole stack at that point, which is the same bet the equity is making. So part of what looks like a lender return is priced off the same thing the owner is hoping for. I'd want to know how a fund splits current from accrued before I read anything else in their materials.

An article calls mezz a second mortgage, another says it isn't

8 replies