How do you price a mezz strip from 65 to 78 percent without just picking a number?

Start from last dollar exposure rather than from the coupon. Your $5m attaches at 65 percent of value and detaches at 77.5 percent, and on $2.4m of NOI the debt yield at your detachment point is about 7.7 percent. That's the number to price against, because it tells you how much NOI can fall before your top dollar is impaired at any plausible refinancing constant. If a lender in three years wants an 8.5 percent debt yield on total debt, the deal supports about $28m, and $3m of your position is looking for a taker with no cushion for the accrued piece or the exit fee.

The split you're asking about shows up in the current pay versus accrual structure, not in the headline. Your 10 current only arrives if cash actually reaches you, and most senior loans of this size run a lockbox with sweep triggers tied to DSCR or debt yield. Once the trigger hits, cash sits at the senior's cash management bank and your current pay converts into accrual whether you agreed to that or not. Model the case where months 14 through 36 are fully accrued and see what your IRR looks like with the exit fee as the only real cash event.

The piece that usually gets underwritten too lightly is the purchase option. Your remedy path assumes you can buy the senior at par on short notice, which means committed capacity of $26m plus, and it assumes you clear the senior's qualified transferee test. Get the senior's actual loan documents and the intercreditor form in writing before you price, since a servicer on a securitized senior can take months to consent to anything.

A few of the terms flying around above are worth having plainly, because they do most of the work in this thread.

Attachment and detachment points are just where your money sits in the stack. On a $10m building with a $6.5m first mortgage and a $1.5m mezz loan, the mezz attaches at 65 percent of value and detaches at 80 percent. Last dollar exposure is that top number, 80 percent, because your final dollar is the first one wiped out if value falls.

Current pay is the interest paid to you in cash each month. Accrual, sometimes called PIK, is interest that adds to the balance and gets paid at payoff. A 13 percent rate split 10 current and 3 accrued means the sponsor writes smaller checks now and a bigger one at the end. That helps the sponsor's cash flow and moves risk onto the lender, since accrued interest is only worth something if there's value left at exit.

Debt yield is NOI divided by loan amount, a quick test of how much income supports each dollar of debt.

One thing that catches new lenders on the mezz side: your security is usually a pledge of the ownership interest in the entity that owns the property rather than a lien on the property itself, so recovery runs through the pledge and the intercreditor agreement instead of a mortgage foreclosure. Whether making commercial loans at all requires a license depends on the state, and that's a question for a licensed attorney in the state where the borrower and property sit.

7.7 percent debt yield at the detach point is where I'd stop and re-cut it. I underwrite mezz to a takeout constant, not to today's cap rate. At 6.5 percent and 30 year amortization the senior constant is roughly 7.6 percent, and total debt of $31m needs about $2.36m of NOI just to cover at 1.0x, which is basically your in place number. There's no coverage at the top of the stack, so your 13 percent is really equity pricing wearing a loan document. Either the $5m comes down to $4m or the current pay comes down and you take more of the return at exit and price the extension option properly.

Ran tender's numbers two ways. Fully performing three years: 10 percent cash on $5m plus 3 percent compounding plus a point at exit gets you to roughly a 13.3 IRR. Now switch off the current pay from month 12 on because of a sweep trigger, hold everything else, and the same deal returns about 13.6 on paper while every dollar of it depends on the exit. Same IRR, completely different risk. That's the case against pricing off IRR at all on a mezz strip.

Every version of this rests on the property being refinanceable in three years at a constant nobody knows yet. Two one year extensions help, though if the extension test is a debt yield hurdle the sponsor can't hit, they aren't extensions, they're maturity.

From the borrower chair, that stack costs about $1.69m a year on $26m senior plus $500k current on the mezz, against $2.4m of NOI. That's a 1.09x on the cash portion before a dollar of capex. I'd have taken that deal a few years ago and I'd be sweating it now. Sextant's version at $4m is the one I could actually service.