Multifamily Short-term Mezzanine Debt & Bridge Loans - What?

9 Replies

I read this statement in the M&M report for 2019 as I'm doing research to zero in on markets to invest in for multifamily: "Lenders have been reluctant to lend on future revenue growth through value-add efforts, resulting in increased use of short-term mezzanine debt and bridge loans to cover the span until improvements deliver the planned returns."

Can someone be so kind as to explain the two bolded terms for me and how to use them effectively when purchasing a multifamily asset? Thank you! - Joe

Mezz Debt is secondary debt on top of the first note or senior debt.  It is usually used at  to bridge the equity gap you may need to transact a deal.  Bridge loans is a First lien position loan that usually includes acquisition and some rehab cost. Usually interest only, higher rates.

Thanks Brent! To make sure I understand, the mezz debt is if I have a purchase price of $1M and the main lender will only finance $550k, the mezz debt would be the difference? Or would it be the difference between $550k (55%) and $750k (75%)? 

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@Joseph Firmin yes mezz debt with only fill the gap between equity and senior debt. They will not lend to 100% so yes 25% equity at the top of the stack, 20% mezz debt in the middle, senior debt 55%at the bottom.

@Joseph Firmin

In addition to what has already been said, I wanted to point out one way that mezzanine debt can effect returns, and in the process hopefully further answering your question "How to use mezzanine debt effectively when purchasing a multifamily asset?"

As mentioned above, investors will often use mezzanine debt to fill the gap between the equity needed to close, and the equity on hand. While that is true, mezzanine debt may also be used by an investor in order to boost returns. If the cost of the mezzanine debt is less than the cost of the equity partners, for example, if equity partners demand a 15% return, and you are able to secure mezzanine debt at 10% to fund some of the "capital stack", your overall return to the equity investors will be increased as the overall return requirement is lowered and the total equity needed to close is reduced. This math equation is why using leverage to purchase real estate increases returns (when done properly of course).

So, if you use mezzanine debt effectively, you may be able to either deliver a higher return to your equity partners, or you may be able to pay more up front for the property, and return the same targeted return to your investors.

Because everything I have mentioned so far has only highlighted the positives of utilizing mezzanine debt, one word of caution...over-leveraging an asset can definitely result in lower returns, negative cash flow, inability to refinance at the end of your loan term and can also result in default. As is always the case when utilizing debt, err on the side of conservatism. Luckily banks don't want you to default on your loan either, so they will pull back when necessary, but just remember they're not looking at your investor returns as closely as you are.

Honestly @Joseph Firmin , if you have never used these type of loan products before - I wouldn't be in a such a rush to jump into one. You need to have enough personal experience, especially where we are at in our current state of market. As you know we're peaking and you can't predict what the market will look like 2-3 years from now. No one for that matter can. If you're not sure how to reposition assets and get out in enough time to replace the mezzanine financing or bridge loan with more attractive financing such as agency debt, then be super careful about the waters you're looking to tread in this current market. Take care. Good luck

Thanks @Tj Hines ! Not currently in a situation calling for this kind of financing, just trying to learn prior to ever needing this type. Great info!