The sponsor sold early and my mezz slice still paid 1.30x

I put $90k into a $3.2m mezzanine tranche on a 112-unit workforce apartment deal, expecting a 36 month hold. The sponsor sold at month 14 and I got paid $27k on top of my principal back, which is more than the interest that had actually accrued.

The reason is a clause I nearly skimmed. Mezzanine debt is the money that sits between the first mortgage and the owner's own equity, and it charges a lot because it gets paid after the mortgage and can lose everything if the deal goes wrong. On this one the coupon was 13% paid monthly. At 14 months my straight interest would have been about $13,600. But the loan documents had a minimum multiple, meaning however early the borrower repaid, they owed enough to get the lender to 1.30 times the money advanced. So the early payoff triggered a make-whole rather than cutting my return short.

The part that nearly broke it was not the property. It was that I almost didn't ask for the loan agreement. I was shown a two page summary with the rate and the term and I asked for the actual document because I wanted to see what happened on default. The minimum multiple was on page 31 and nobody had mentioned it, and I only understood it because I asked the sponsor's counsel to explain the clause in plain words on a phone call.

What I would keep: asking for the full document even when the summary looks complete, and asking specifically what happens if the borrower pays me back early. Early repayment felt like a good problem before I knew the answer, and it would have been a mediocre one without that clause. Every deal is documented differently, so this is a question to ask on each one rather than a feature to assume.

Answer

3brandonlee36Passive

The clause did the work, and I'd want you to be clear with yourself about which part of this was skill. Asking for the document was skill. The sponsor selling at month 14 into a market that gave them a price was luck, and that same sale in a worse market is a refinance that doesn't close, which is where mezz positions get hurt.

Run the other direction on your own numbers. If the sale had fallen through and the senior loan matured with the property worth less than the two loans together, your 13% coupon goes to accrual and your $90k is behind a first mortgage that has to be paid in full before you see a dollar. Same clause, same document, no payment. The minimum multiple protects you against being repaid too early. It does nothing about not being repaid at all.

The question I'd ask on the next one is what the senior loan's maturity date is relative to your expected hold, and what happens to your position if the borrower needs an extension and the senior lender wants a paydown to grant it. That paydown usually comes from somewhere, and it isn't the senior lender's pocket.

Also worth asking who else was in the $3.2m and whether any of them can make decisions you can't. On a $90k slice you're almost certainly a passenger.

The sponsor sold early and my mezz slice still paid 1.30x

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