Pref Equity Vs Mezz: What Is The Best Option for You?

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Which type of financing suits you the best? Read below the difference between pref equity vs Mezz.

All of this implies that debt funds are becoming a more attractive choice for commercial borrowers, particularly those seeking construction and bridging loans for higher-risk buildings.

 

Mezzanine debt and preferred equity both serve a similar purpose in a capital structure, but they differ significantly. A mezzanine loan and preferred stock program, in which one or both types of capital are used, can dramatically improve a company’s access to finance and alter its future direction. Mezzanine debt is a type of debt that is a cross between subordinated debt and equity. Many of the standard characteristics of a loan, such as a term, interest rate, covenants, and control provisions, are included in mezzanine financing. Due to the warrant, which allows the lender more return upside ahead of regular shareholders, it also incorporates aspects of preferred equity.

 

The differences between pref equity vs mezz for real estate, how each is structured, and how real estate sponsors employ both types of investments to produce profits in a private equity real estate investment will be discussed in this article.

 

Features of Preferred Equity

The following are some of the characteristics of preferred equity financing:

 

  • Joint venture partners include preferred equity investors and the developer or general partner.

 

  • The general partner is in charge of the investment’s day-to-day operations, with the preferred equity investor having the ultimate say on significant decisions.

 

  • Regular repayments are made to preferred stock investors based on an agreed-upon timetable or structured to accumulate.

 

  • In the event that the general partner defaults, a preferred equity investor may remove the general partner from the control of the joint venture.

 

The general partner may be required to issue a “bad boy” guarantee to the preferred equity investor, which protects the general partner from personal liability.

 

  • The required redemption date for preferred equity investments is usually the same as the maturity date of any mortgage loans.

 

Preferred equity can have a “hard” structure with more debt-like features, a “soft” structure with more equity-like characteristics, or a hybrid structure.

 

Features of Mezzanine Debt

 

  • A mezzanine debt investment often has the following characteristics:

 

  • Subordinated to senior debt, with preferred equity and common equity taking precedence.

 

  • Senior debt has a higher interest rate, but the preferred stock has a lower rate of return.

 

  • In most cases, it is not backed by real estate.

 

  • A mezzanine debt loan might have a shorter duration than a senior secured debt loan.

 

  • Interest-only payments can be made rather than repayments that are amortized throughout the loan’s length.

 

In most cases, the mezzanine investor will be offered the option to work with the sponsor to cure the defaulted senior mortgage or to purchase the defaulted senior mortgage for the same price as the outstanding senior debt.

 

There are various benefits to adopting a mezzanine or preferred equity financing. Mezzanine loans, which allow the sponsor to bridge the gap between the senior lender and common stock, are likely to appeal to anybody trying to secure equity. Over-leverage is frequently avoided by sophisticated borrowers. As debt climbs, so does the risk of foreclosure.

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