Mezzanine debt and loans are fast becoming the way to invest in commercial property for investors in Australia. That’s for good reason, too. Mezzanine financing is formulated in a way to mitigate the risk of investment in commercial property by using a mixture of debt and owners’ equity.
Where can Mezzanine Loans and Debt be Used
Mezzanine loans help the lenders advance through the capital stack more than what conventional debt would let them. This means that lenders can use them for refinancing and recapitalization when the amount owed. The more relevant use for investors looking for investment in commercial property is that mezzanine loans give a cushion to offset the amount of equity that they have at stake.
So that means that the investors can use a mix of equity and mezzanine debt to allow them to have some stake in the property without being overburdened by it. It’s helpful when an investor such as you, are trying to build commercial property from the ground up.
How it Works
When an investor opts for a mezzanine loan, they don’t have to go through the trouble of offering up collateral like secured senior debt. Instead they can offer warrants or equity instruments such as a share of ownership in the commercial property that the investor is investing into mitigate the risk of default. This means that there is better value in mezzanine debt that just offering up equity, and one can potentially get more money to invest in the commercial property.
Although it might be considered risky by some, it has greater potential for returns and therefore, is offered as an investment option by companies like
Typically, a mix of preferred equity and mezzanine debt is used to invest in commercial property. You can think of mezzanine debt as resembling the behaviour of shares. This is because when you are borrowing through a mix of preferred equity and mezzanine debt, you are giving certain rights to the borrower.
If the commercial property you’re investing in is a business (you’re investing for expansion) you don’t have to place any collateral on the line, but you can give out (stock) call options or a share in the business if you default on payments. This is risky for the borrower, but that indicates that the rewards are greater.
The rewards are greater because when you invest in a property as an equity investor (a mix of preferred equity and mezzanine debt), you get to enjoy the income from the commercial property and get better returns on the appreciation of the property itself.
Whether you decide to get a mezzanine debt or loan as well as equity is entirely dependent on your income preferences. Just remember that it’s all about how much risk you are willing to take on for a mix of steady passive income or increased capital gains.
A secured senior loan may be less expensive than a mezzanine debt but the payoffs for mezzanine are greater when you invest in commercial property.