-by Sunny Sajnani, Senior Director
With a large number of high-leverage mortgages coming due over the next few years, subordinated financing is an attractive option to bridge the gap between today’s lower, senior mortgage leverage and the loan payoffs.
There are several different types of subordinated financing. Depending on the type of senior mortgage a deal has in place, one of the following types of subordinated financing could be a fit:
1. Mezzanine Loan – A mezzanine (“mezz”) loan is actually a loan made to a partnership that is subordinated to the senior financing. A mezz loan can be secured two different ways:
- Second Lien – This collateral position requires a second mortgage that is recorded on the property. This route requires more documentation (mortgage, title policy, etc.) and costs more (recording fees, title insurance, etc.). In a default situation the lender has a lien on the property and can foreclose on their 2nd mortgage and keep the senior mortgage in place, provided a default on the 2nd mortgage does not trigger a default on the first mortgage.
- Pledge of Partnership Interests – This route is easier to document. The lender takes a pledge of your partnership interests rather than a second lien. In a default situation, the lender can foreclose on the partnership interests to take control of the borrowing entity.
Both forms of mezzanine loans outlined above usually will require senior lender consent. If the senior lender will not consent to a mezz loan, then preferred equity may be a good solution.
2. Preferred Equity – this form of subordinated financing is written directly into the partnership agreement of the entity that owns the property. Typically, the subordinated lender is considered a “Class A” shareholder, and the equity is considered a “Class B” shareholder. The Class A shares normally do not have any ownership in the partnership, but they get their preferred return (interest) before the Class B shareholders participate in cash flow. In the event of default, the Class A shareholders (preferred equity lenders) can foreclose on the Class B shares and take control of the borrowing entity.
The pricing of either mezz or preferred equity is a function of the specific transaction where the underwriting will focus on the stability of the property’s cash flow, leasing/occupancy risks, and the terms of the underlying first mortgage financing. MCA has recently seen these mezzanine and/or preferred equity transaction price in the range of 10% to 15%, again depending on the specific situation.
In many cases borrowers are coming up with a case of the “shorts”… meaning that they need to contribute additional equity into a deal to refinance. Many borrowers are considering subordinated financing in effort to avoid having to bring new equity to the table. MCA has closed all types of subordinated financing and can tailor a capital solution if you are coming up with the “shorts.” Please contact any one of our MCA Senior Directors to further discuss your particular capital requirement.