Mezzanine financing is a mix of equity and debt financing that grants the lender the ability to convert the debt into an equity stake in the company in the event of default, often after venture capital firms and other senior lenders have been paid. It is between senior debt and equity in terms of risk.
Equity instruments are integrated with mezzanine debt. Attachments, often referred to as warrants, raise the value of the subordinated debt and provide you more leeway when negotiating with bondholders. Mezzanine finance is commonly utilized in conjunction with acquisitions and buyouts because it may be used to give new owners priority over current ones in the event of bankruptcy. Keep reading to know what is mezzanine debt in real estate.
Understanding Mezzanine Financing
One of the riskiest types of debt is mezzanine finance, which fills the void between debt and equity financing. It is inferior to pure debt but superior to pure equity. But because it frequently obtains rates between 12% and 20% per year, and occasionally even as high as 30%, it also implies that, when compared to other loan kinds, it delivers some of the largest returns to investors in debt.
Mezzanine financing carries a higher interest rate than the senior debt that businesses would otherwise obtain through their banks but is significantly less expensive than equity in terms of the total cost of capital. As a result, mezzanine financing can be seen as either very expensive debt or less expensive equity. Additionally, the value of the company’s shares is not as diluted. Mezzanine financing ultimately enables a business to raise more capital and boost returns on equity.
Companies will use mezzanine finance to support acquisitions with short- to medium-term time horizons or to fund specific growth projects. These loans are frequently financed by current investors and long-term financiers of the company’s capital. There is, in fact, no responsibility to repay the money obtained through equity financing in that instance of preferred stock. The corporation has more liquid money accessible to it for investing in the business since there are no required payments to be paid. Even a mezzanine loan only requires interest payments until it matures, which gives the firm owner additional free capital.
Mezzanine loan structures frequently share a number of traits, such as:
- Mezzanine loans take precedence over preferred and ordinary shares but are subservient to senior debt.
- Compared to regular debt, they provide greater returns.
- They frequently have unsecured debt.
- The principle of the loan is not amortized.
- They might be set up with a mix of fixed and variable interest rates.
Mezzanine finance is a type of financing utilized in specific real estate transactions. It is intended to bridge the gap between a senior loan and the available equity. Utilizing mezzanine finance in a real estate investment has the advantage of increasing returns by lowering the amount of equity required in the transaction.
Mezzanine finance does, however, have dangers. They are placed second in line for repayment in the case of bankruptcy or foreclosure, which increases the transaction’s overall cost of capital. The property must perform well enough to pay the debt service on both the senior and mezzanine loans because it may also have significant fees. These elements should be taken into account throughout the underwriting procedure. If you want to know more about mezzanine or DC PACE, connect with clearwatercm.com.