Using Mezzanine Loans for Commercial Property Transactions
Securing capital for commercial property can be hard to do, but if traditional and non-traditional lenders alike aren’t showing interest in financing you, you may have another option. Mezzanine loans are a bridge between equity and debt and although they come with risks, they also come with high returns.
A Quick Look
Mezzanine loans are part of the commercial mortgage market and are popular among property owners. Senior loans are about 60 percent of asset value on commercial real estate with mezzanine debt making up another 10 percent to 20 percent and equity making up the rest. Because it is a fixed-income product, it has a consistent dividend yield. The absolute rate depends on many things, including where the property is, what type of property it is and the quality of the tenant. This type of debt is known as a hard asset investment, meaning the borrower’s interest in the property is what secures it. If the borrower fails to pay back their loan, the lender seizes the property.
Diversified Investment Portfolios
Many commercial property owners turn to mezzanine loans as a way to improve and diversify their investment portfolios. One reason for this is to fulfill the belief that 5 percent to 10 percent of an investment portfolio should be made up of commercial real estate or other alternative investments. Government bonds, money market accounts and other investments that protect capital don’t have very high yields, making it harder for the investor to gain wealth. Mezzanine debt can remedy that even when you factor in its risks.
The Risks Involved
Although a mezzanine loan adds diversification, boosts income and provides exposure to underweighted sectors, it also has risks. Most commonly, the interest rate is the biggest risk. This is because if Treasury yields increase, a debt fund’s value will decrease. If the performance for real estate takes a downturn, mezzanine investors would be affected. Rising vacancies in office buildings, shopping malls and even apartment buildings reduce income and increase the risk of the borrower going into default on the loan. Despite the risks, mezzanine debt has a long history when it comes to the commercial real estate market and it doesn’t look like it will be going anywhere anytime soon, especially because banks do not lend to commercial real estate investors as often as they once did.
If you are considering a mezzanine loan, ask your financial advisor to help you weigh the risks versus the rewards first. Typically, this type of loan is best for experienced investors.