At what point does 10 to 15 percent stop paying you for the subordinate seat?

Question

Mezz targets 10 to 15 percent. Common equity in the same deals is usually pitched at high teens and up. So you're giving up several hundred basis points of upside in exchange for sitting ahead of the equity, a contractual coupon, and a pledge you can foreclose on.

The trade looks obvious at the top of the range. A 15 percent mezz coupon on a stabilized asset with a conservative senior in front of it is a good place to sit. At 10 percent on a transitional deal where the senior is already at 65 percent of a value nobody has tested, I'm less sure. You're taking equity-shaped risk in the downside scenario, because if the property is worth less than the senior balance your pledge is worth nothing, and you're taking debt-shaped returns in the upside.

Where I keep landing is that the number matters less than the attachment point. But people I respect argue the opposite, that the coupon is the only thing you can actually contract for and everything else is a story about value.

So which one binds your decision. Do you have a coupon floor you won't go below regardless of the stack, or is it attachment and last dollar exposure that decides and the rate is whatever the market gives you?

stephen_ok9 · Answer

Attachment, and I'd say the coupon floor is a bit of a trap for someone at my stage. A 15 percent quote on a deal where mezz last dollar sits at 85 percent of an appraisal from a hot quarter is worse than 11 percent behind a 55 percent senior. The higher number is telling you something and it isn't that you're being generous to yourself.

brandonlee36 · Answer

Both, and they interact. If I can't get double digits I'd rather take the equity and the upside, and if attachment is bad no coupon fixes it. So the floor screens out deals and attachment decides among the survivors.

tashaford30 · Answer

@meridian's appraisal point is the one I'd worry about most. Last dollar exposure is a percentage of a value estimate, and the estimate is the soft part. I'd want to know what the number looks like against replacement cost and against in-place cash flow before I trusted the percentage at all.

dmitri_v6 · Answer

I voted attachment, but the thing I'd actually negotiate is neither one. Whether I can cure the senior, how long the standstill runs, and what the qualified transferee test lets me do with the position later. A 14 percent coupon with a two year standstill and no cure right is a 14 percent coupon you might collect for eleven months.

At what point does 10 to 15 percent stop paying you for the subordinate seat?

4 replies