The sponsor won't say why they prefer mezz over pref on the same gap

The senior loan documents almost certainly prohibit additional debt at the property level, and a mezz loan at the owner entity may trip a change of control or additional indebtedness covenant depending on how it's drafted. That's the most common reason a sponsor pushes pref. It isn't sinister, it just means the mezz option they offered you might not actually be available and they haven't checked with the senior lender.

Ask them directly for the additional debt and transfer sections of the senior loan agreement. If they won't send those, that tells you what you need.

I'm reading this twice like I read everything. Can someone explain why the mezz lender is safer if it doesn't have a lien on the building? I thought a lien on the building was the whole point of being a lender.

@juniper the mezz lender holds a pledge of the ownership interests in the company that owns the building. If the borrower defaults, the mezz can foreclose on that pledge and end up owning the company, which owns the building, subject to the senior mortgage that's still sitting there. It's a faster process than a mortgage foreclosure in a lot of states, though the exact procedure and timing differ by state. The pref holder's remedy usually lives in the operating agreement, removal rights and forced sale provisions, and enforcing those tends to mean going to court.

Six weeks of underwriting and they still won't answer a direct question about why they prefer one structure. I run a much smaller business than any of this but that answer is free and they're not giving it. I'd want to know what else is free and not being given.

@thatch is saying what I was thinking. Office to residential conversion, a budget the investor already thinks is light, and a sponsor who won't share loan documents. The 1.5% return difference between the two structures is not the interesting number in this post.

Naive question. If the pref is 9% current and 5% accruing, does the accruing part actually get paid, or is it only paid if the sale at completion works? Because it reads like half the return depends entirely on the exit.

@wren that's right, the accrual compounds and gets paid at the exit or the redemption date, so it's exposed to the sale. Which means @windlass, your 14 versus 12.5 comparison isn't apples to apples at all. The mezz 12.5 is current cash. The pref is 9 cash and a claim. If the conversion runs 30 months instead of 24 and sells for less than the model, the mezz holder collected 12.5 the whole time and the pref holder collected 9 and a number on a page.

@kestrel that's the clearest way anyone has put it in this thread. Though doesn't the mezz current pay also depend on the property producing cash? On a conversion there's no income for 24 months, so the 12.5 is coming out of an interest reserve funded from the loan proceeds. If the project runs long the reserve empties and the current pay stops being current.

@bramble is right and that's the question I'd put back to the sponsor. How many months of interest reserve are funded, and funded by whom. On the conversions I've watched from the land side, the reserve was sized to the 24 month schedule with nothing for the 6 month buffer they keep talking about in the model.

I understood maybe half of this and I've read it three times, which is fine, I'm writing down the terms. The thing that stuck: the sponsor won't send two sections of a document they already have. Everything else in the thread is math and that part isn't.