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The Capital Stack Part Three (Mezzanine Debt) - YouTube
Channel: Multifamily Investing Made Simple
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[Music]
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hello
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and welcome to multi-family investing
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made simple a podcast that's all about
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taking the complexity
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out of real estate investing so that you
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can take action
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today i am your host anthony vestino not
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the chino
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sometimes you know but manly vecino of
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invictus capital
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joined as always by dan never kroger
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never krieger
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always krueger how you doing again
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i'm doing good i feel like we really
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solidified what our names are and how
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they're pronounced
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i wanted to make sure everybody knows i
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get the question a lot i get the
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question a lot of like people go
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is it vecino is it vegeta a lot of times
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i want to say
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vincino they want to add extra letters
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in there and i know that you've
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i've had issues with your name in the
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past everybody does
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if you go back to those early podcast
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episodes you
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you would create you're left with the
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impression that i do not know what dan's
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name is
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and you'd be right yeah we're working on
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it's always a work in progress to work
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in progress yeah
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so dan what what are we doing today we i
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well
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actually no you know what i'm gonna take
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this one you just sit there
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look pretty so today we are going to
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continue
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our five part series into the capital
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stack
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if you missed last week's episode you're
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going to want to start there if you have
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no idea what the capital stack is
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go start with that episode get get the
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high level view
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because now we're going to go another
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level deeper last week we covered the
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senior debt
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this week we're covering the mezzanine
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debt or also known as the junior debt
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or sub subordinate debt uh
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so dan walk us through how is this debt
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fundamentally different than
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senior debt yeah well people remember
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from the last
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um episode in this series
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as we work our way up this the capital
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stack
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um the uh the the risk profile
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of the position uh slights uh starts to
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increase slightly
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and uh for that reason the cost of
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capital starts to increase slightly so
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that that senior debt that we talked
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about last time is going to be the
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lowest cost
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of your capital there interest rates on
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that are going to be you know these days
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around three percent and that's the cost
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of your capital it's what you're paying
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to get that money
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in part of your deal and so when you go
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up next what happens is
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um when you get into the mezzanine
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subordinate or junior or whatever you
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want to call it
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that next layer of debt if you do have
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it
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is going to be in the second position uh
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which means that there's going to be a
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second position
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in the a second position lean on the
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property which means that if things go
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south that senior debt gets paid first
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and this mezzanine subordinate junior
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debt
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is going to be in second position so if
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there's no more money left
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in liquidation if you know things blow
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up then these guys might be sol
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and so for that reason the cost of
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capital this level is going to be
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a bit higher um i don't really have a
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range
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to provide for people on that but just
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know that it's going to be more than
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the senior debt but it's probably going
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to cost you less than giving up equity
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yeah it definitely should cost a little
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bit less than giving up equity if it's
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not then you probably
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got some pretty bad terms there i i
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would think your junior debt should
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probably come in
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a couple basis points or you know maybe
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maybe six points yeah six to eight six
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to eight percent
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i think is probably pretty
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straightforward here the thing with
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mezzanine
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is that sometimes it's not
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collateralized which means that it's not
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backed by the property and that's
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because
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whoever whoever's sitting in the senior
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position might be saying we don't want
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anybody else
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coming in behind us uh collateralized so
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that that debt position
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that while they would get paid out
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before the equity people the
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stakeholders
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they don't necessarily get to claim the
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property if it goes
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um goes south so it is a little bit
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riskier position but it's still less
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risky than
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uh preferred equity or common equity
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which we'll be talking about
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in following episodes now who would we
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typically be getting
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mezzanine debt from like is this from
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the bank is this from a different entity
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like who are we getting this from
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either one honestly it could be it could
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be a bank um
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it could just be a uh a private equity
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fund that doesn't necessarily want an
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equity position and a deal they'd rather
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just do a debt
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feel it could just be an individual like
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a like a hard money lender
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um or someone that's that's like a hard
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money lender when we're talking about
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big
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uh apartment buildings we're not
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typically going to the hard money
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lenders per se
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uh but just for the sake of
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differentiating this
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individual from some of these larger
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organizations where it's it's just a guy
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with some money that that wants to
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invest but he wants to do it via debt um
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you know it could be any
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any type of entity it's just uh really
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the only thing that makes it mezzanine
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is the fact that it comes after the
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senior debt
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um you know and like camp you mentioned
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there there doesn't necessarily need to
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be a lien on the property
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uh for this position and if there isn't
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then that would probably bump the uh
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the cost of it up a smidge higher so
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yeah
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i think it would be pretty rare to get
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let's say like a bank coming in on
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second position without it being
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collateralized like a bank
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isn't probably going to want to take
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that position but a really common one
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would be seller financing so if you've
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negotiated with the seller to carry back
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a part of the down payment or something
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like that
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that's a perfect example of mezzanine
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debt it's not secured in a lot a lot of
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cases by the property itself
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they're bringing a little extra money in
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they're just getting their coupon
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another case might be uh in
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just investors who want a
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lower but more conservative return
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that is sits higher in the cap stack so
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some operators will structure their deal
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where they
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offer common equity and those people
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typically have the potential for the
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highest returns but they also carry the
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most risk because they get paid last and
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we'll talk about that in future episodes
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and as you go down the capital stack
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sometimes they do slot people into that
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debt position where it's just a
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six percent return you get paid out
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before anybody else gets theirs
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after the senior debt gets theirs and
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that can be really good for risk-averse
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investors who
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really don't care about living that that
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high life of the potential high returns
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they
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just want to say i'm getting this five
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six percent
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i want to clip my coupon each month and
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that's all i need um
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so depending on your risk profile that
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that might be the type of
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operator type of deal to go looking for
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yeah and yeah just to kind of clarify
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here
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um for people that you know if you see a
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capital stack that has
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mezzanine debt in there that doesn't
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necessarily mean that an operator is
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over
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leveraging or anything like that a lot
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of times um
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some operators might get some really
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amazing terms from certain
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institutions like cmbs debt or something
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like that
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where you can get some really really
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really attractive terms however they
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don't like to go above
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um 50 to 65 leverage and so the mez debt
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really comes in to get it up to that
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typical uh safe 75 so maybe a certain
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institution will
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offer some amazing terms for 70 or 65
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leverage
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and then the the next 10 percent to get
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up to a total 75 percent
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ltv uh structure would be uh in
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from mez debt so it might not be that
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you know people are over leveraging it
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might just be they like they want to get
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more
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um strategic with with their with their
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debt structure to really
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uh bring down their their total weighted
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average cost of capital
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and and structure something very
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specific and usually this is more common
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in
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in larger more complex deals with more
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moving pieces where they've got to kind
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of piece a few things together
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most of the deals we do we like to keep
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it nice and simple uh one bank in the
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senior position
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75 leverage maybe 70 maybe 80 depends on
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the deal but we'd like to keep it fairly
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simple but usually you'll see some of
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these more exotic capital stacks as you
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get into
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bigger uh deals with more institutional
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level operators
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i'm curious you might have the answer to
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this i haven't really considered this
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if you were to take out a construction
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loan so you go to buy your property and
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a lot of times you can take out a
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construction loan
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with the bank that you're taking up the
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the mortgage they'll just cover the the
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cost of what
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that's going to look like and then you
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take out a draw if you were to take out
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and that would put it in the senior debt
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position
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because it's coming from the same bank
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as my my guess
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but if you were to take out a
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construction loan with a secondary bank
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would that be considered mezzanine debt
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or because i'm guessing it's not
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collateralized
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in a lot of cases i'm kind of leaning
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towards no but i also
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i'm not sure if there's really going to
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be an instance where you take a
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construction loan from
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a institution that's not doing the
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senior debt
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i've always seen those you know coming
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from the same place i've never seen
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those split up per se but with that said
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uh we don't do a lot of construction
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loans and we don't really do new
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developments so there might be some
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nuances in
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in you know the new development space
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where that is a thing uh yeah
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it gets a little it gets a little
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complex there because i know we were
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talking to some new developers recently
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and they had a capital stack that was
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just
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obscene it was crazy they had like 17
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different sources of
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capital and we're like whoa that's a
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complex deal right there yeah it can get
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pretty crazy especially like we
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mentioned in previous
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episode i think the intro episode uh you
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know if you're doing something that's
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utilizing tax credits from a city or a
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county or something things can get
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fairly complex
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um while you're pulling all the pieces
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together to capitalize the project
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so we like to keep it simple here uh we
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like it that way i think our investors
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like it simple as well because you can
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look at it and
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know exactly what heck's going on which
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i think there's something to be said
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about that
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yeah it's nice not having to to need a
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advanced degree to understand what's
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happening um
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and that's the thing with real estate
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that's one of the reasons we like it
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this is why we named the show what we
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did why we wrote a book called passive
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investing made simple is that
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we do believe that these investment
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vehicles at their very core
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are simple things and when there's
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complexity added in it's usually
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unnecessary yeah you know i think some
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people think they get bonus points for
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uh complexity
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um and you don't you know
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you don't i think that's just uh ego and
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something at play there but there are
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some people out there that that
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i think try to make things more complex
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and more exotic because they think they
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they look more advanced and therefore
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better but you know at the end of the
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day some of the
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the best dealers deals are the simplest
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ones
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exactly exactly so i think that's going
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to conclude it for the mezzanine debt
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unless you have anything else to add i
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think we have tackled
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the second part of the capital stack so
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far we've hit the senior debt the
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mezzanine debt
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tune in next week as we dive into the
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preferred
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equity side of things it's uh that gets
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a little bit fun actually
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um it's been very popular in the in the
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last year or two as operators are
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looking for more creative ways to
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deduce returns in an environment where
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deals are getting harder and harder to
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find
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we're seeing seeing this instrument
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being utilized a little bit more often
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so
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that's going to do it for us guys now
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remember depending on when you're
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listening to this the book might not be
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out yet but the book is coming
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august 11th passive investing made
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simple if you
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want to get your free copy shoot me an
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email and say hey anthony i want a free
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digital copy i'm going to send it to you
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and then
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if you leave a review on amazon and you
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send us a snapshot of that
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i'm going to sign the book dan's going
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to sign the book we're going to put it
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in the mail
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for free a physical copy and it's going
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to be sent to you with a bow on top
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there might not actually be a bow don't
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expect probably not to be involved
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so if you don't know yeah we don't have
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any bows so if you want a free book
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that's your avenue to free book nirvana
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otherwise that's going to do it for us
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guys we love you we adore you we
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appreciate you and we'll see you next
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week
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you
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