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Mezzanine Debt / Subordinate Lien- Explanation & Example | Mezzanine Financing in Real Estate - YouTube
Channel: Trevor Calton
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mezzanine financing or mezzanine debt is
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another name for junior debt that has a
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subordinate position to the senior debt
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and that typically commands a higher
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interest rate mezzanine debt is commonly
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used in commercial real estate and it's
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the commercial equivalent of taking out
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a second loan or a home equity loan on a
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home but it's often structured with a
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much wider variety of potential loan
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terms including an option to be
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converted into equity
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senior debt takes priority over junior
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debt because it is first in line to
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receive the income and also first in
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line to receive any proceeds should the
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project fail and need to be liquidated
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junior debt or mezzanine debt is next in
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line in priority and is typically more
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expensive because of that higher risk
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often senior debt holders will only lend
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up to maybe 60 or 70 percent of a
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project
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and unless the equity holders are able
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to come up with that additional 30 to 40
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percent then mezzanine or junior debt is
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necessary
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sometimes junior debt can be called
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bridge financing because it bridges that
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gap between the senior debt and the
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equity
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sometimes novice investors will get
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scared of the prospect of using
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mezzanine debt because of the higher
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interest rate but if you dig a little
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bit deeper into the math you'll see it's
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not as daunting as it might appear at
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first imagine we have a one million
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dollar property the buyer only has two
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hundred thousand
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to put down as a down payment the lender
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will only lend seven hundred thousand
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which leaves a one hundred thousand
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dollar gap that the borrower can fill
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with a mezzanine loan now imagine the
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senior loan has an interest rate of four
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percent amortized over say 25 years
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and the mezzanine loan has an interest
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rate of 10 percent it might seem like
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that's a very expensive loan but if it
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allows the borrower to get the deal done
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it might be worth it and it might not be
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as expensive as you think let's take a
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look if the senior loan is amortized
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over 25 years that would be 300 months
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it has an interest rate of 4 per year we
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divide that by 12 to get the monthly
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interest rate the loan amount would be
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700 000 that's our present value that
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gives us a payment of 3694.85
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per month let's look at the same thing
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for the mezzanine loan the mezzanine
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loan has the same terms
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300 months or 25 years but an interest
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rate of 10
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of course we divide that by 12 because
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we need the monthly rate we put in the
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loan amount for a hundred thousand we
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get a monthly payment of 908. well if we
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add those two up that means we have a
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total monthly payment of 4603 56
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on 800 000 worth of debt
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if we back into the interest rate
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solving for i
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we get
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0.4035
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which is our monthly
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interest rate so we have to multiply
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that by 12
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and then we see that we have a 4.84
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interest rate
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combined and what we call that is the
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weighted average cost of capital so
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whenever you're analyzing a deal and
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looking at the potential to use
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mezzanine debt in addition to the senior
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debt don't be daunted by the higher
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interest rate until you calculate the
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weighted average cost of capital because
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in this particular case the difference
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between the four percent on the senior
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loan and the weighted average cost of
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capital of 4.84 is not that much and
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could potentially make it so that the
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borrower can get the deal done where
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without the mezzanine financing they
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would not have been able to well if you
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made it this far i want to thank you for
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watching and if you enjoyed this please
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like and subscribe and all that and
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definitely leave me a note in the
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comments if you have questions or if
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you'd like to see other videos and if
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you're looking for more in-depth
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training check out my courses at the
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link below this is trevor thanks for
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watching
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you
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