How mezzanine financing fits into a deal

Mezzanine financing sits in the capital stack between the senior mortgage and the owner’s equity. Lenders price mezzanine debt higher than senior loans because it is subordinated — they are paid only after the senior lender in distress — and they often receive higher interest, fees, or an equity conversion feature to compensate for that risk (Investopedia).

In my practice advising commercial real estate buyers, mezzanine facilities are most useful when a borrower must close a deal but prefers to preserve cash for renovations, leasing, or reserves. Unlike an equity raise, mezzanine debt can be structured with a fixed term and a clear exit (sale, refinance, or conversion).

Typical structure and documents

  • Senior loan (first lien mortgage) — primary collateral and lower interest.
  • Mezzanine loan (subordinated) — generally secured by equity interests in the borrower entity rather than a second lien on the real property; enforced via pledges of membership interests and intercreditor agreements.

Key documents to expect:

  • Mezzanine loan agreement and security agreement
  • Pledge of membership or equity interests
  • Intercreditor agreement defining remedies and payment priority (see our guide on intercreditor agreements)
  • UCC filings and, where applicable, subordination agreements

Related internal resources: see our glossary entries on Mezzanine Loan and Intercreditor Agreements: Who Gets Paid First.

Example (simple, illustrative)

Purchase price: $10,000,000

  • Senior mortgage: $7,000,000
  • Mezzanine loan: $1,500,000
  • Seller/owner equity: $1,500,000

This mix allows the buyer to increase leverage and preserve $1.5M in operating capital. The mezzanine lender may charge a higher coupon and require an option to convert to an equity stake if the borrower defaults or misses covenants.

Pricing and terms (what to expect in 2025)

  • Term: commonly 3–7 years with negotiated extension options.
  • Interest: varies by risk and sponsor track record — often mid-to-high single digits to low double digits (effective cost depends on fees, PIK interest, and equity kickers). Refer to FINRA and market sources for current pricing norms (FINRA).
  • Security: typically a pledge of equity interests in the borrowing entity rather than a second mortgage; enforcement is governed by the intercreditor agreement.

Negotiation points and structuring tips

  • Intercreditor provisions: push for clarity on standstill periods, cure rights, and foreclosure remedies. These clauses determine how the senior and mezzanine lenders interact during default.
  • Cure and payment waterfall: negotiate timelines and default remedies to avoid unintended loss of control.
  • Equity conversion vs. warrants: if the lender requests an equity upside, define conversion thresholds carefully to limit dilution.
  • Exit strategy: lenders want a clear path to repayment — sale, refinance, or refinancing into permanent capital. Include defined exit milestones.

In practice I recommend building a two-way sensitivity model showing cashflow at varying rent, vacancy, and cap-ex scenarios to convince mezzanine lenders your business plan is resilient.

Pros and cons

Pros:

  • Preserves sponsor cash and equity for operations or future acquisitions
  • Faster to arrange than large equity raises in many cases
  • Flexible structures (PIK interest, interest-only periods)

Cons:

  • Higher cost than senior debt; total financing cost can be materially higher
  • Potential for equity dilution if conversion features are triggered
  • Complex documentation (intercreditor and subordination agreements)

Common mistakes to avoid

  • Treating mezzanine like free capital: always model full financed cost, not just the headline coupon.
  • Ignoring intercreditor terms: these determine remedies and whether the sponsor can operate the asset during distress.
  • Weak exit planning: mezzanine lenders expect a clear refinance/sale timeline.

Quick borrower checklist

  • Prepare a 3–5 year pro forma and sensitivity analyses
  • Assemble sponsor track record and rent-roll/lease abstracts
  • Get senior lender pre-approval or term sheet before negotiating mezzanine terms
  • Engage counsel experienced in intercreditor and pledge documentation early

When to choose mezzanine vs alternative funding

Choose mezzanine when you need to close a gap quickly, want to avoid immediate equity dilution, and have a short- to medium-term exit plan. Consider alternatives — preferred equity, JV capital, or seller financing — if you want to avoid pledge structures or potential conversion scenarios. See our related page on Loan Subordination Explained: Who Gets Paid First for more on priority issues.

Regulatory and tax considerations

Mezzanine financing often uses equity pledges, which can have tax and state-law consequences. Treatment of interest, PIK, and conversion rights can affect issuer tax profiles — consult tax counsel. For a market primer, see Investopedia’s overview of mezzanine financing (https://www.investopedia.com) and regulatory notes at FINRA (https://www.finra.org).

Professional disclaimer: This article is educational and does not constitute legal, tax, or investment advice. Consult your attorney, tax advisor, and lending counsel to structure mezzanine financing for your specific deal.

Sources and further reading

Author note: In over a decade advising commercial buyers I’ve found the best mezzanine structures balance lender protection with operational flexibility — negotiate clear intercreditor mechanics and an explicit exit plan before you accept capital.