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National Mortgage Professional
Jun 22, 2006

Mezzanine/equity financing--What is it?Ari MillerMezzanine equity financing What on earth is mezzanine/equity (ME) financing, anyway? If your daily commute takes place anywhere near mine, you probably see billboards all over the place while you're driving down the highway on the way to work, picturing a couple of cowboys talking about ME. The billboards look nice, but they don't really tell me what an ME loan is or what to do with it if I find one. Here's what it is in a nutshell: ME financing is a high loan-to-value (LTV) second mortgage on a commercial or multi-unit residential property, which must be made to a corporation. ME LTVs are computed on a case-by-case basis, but can often go up to 100 percent. The mezzanine or equity portion is a loan to cover the difference between the first mortgage, plus down payment, and the sales price. Did you ever think that someone could get a deal like that? There are programs out there for commercial buyers to borrow their down payment money. These loans are not for everyone. Typically speaking, these used to be very big loans on very high-end properties. Most loans would start at $2 million or so and go all of the way up to the sky; the properties values started at approximately $10 million. However, now there are some lenders who are catering to the smaller investor's needs. There are new programs out that will help an investor buy a half-million- or million-dollar property. Just to be clear, here's an example of what I'm talking about: An investor wants to purchase a multi-unit apartment building for $1 million. He can secure a loan from a local bank or portfolio lender for $750,000. The problem is that he doesn't have the $250,000 plus closing costs for the down payment. For argument's sake, let's say that he only has $100,000. For this example, just to keep the math simple, let's assume that there are no closing costs (or that the seller is paying all of them). Property type: 20 apartments Purchase price: $1 million First mortgage loan: $750,000 Down payment needed: $250,000 Amount the buyer can come up with: $100,000 Shortfall: $150,000 If you've never done an ME loan, at this point, you tell the borrower goodbye. There's nothing you can do. The deal is dead and you have to move on to the next one. Now there's another way. An ME lender will step in and lend the borrower the $150,000 needed to make the deal happen. Does that sound too good to be true? It's not. Here's another example. A buyer is under contract for a property for $500,000. The problem is that the seller has a $200,000 mortgage with a $50,000 prepayment penalty. The mortgage is assumable, and the seller will not pay the penalty (or he'll pay it and jack the price up by $50,000 to recoup the money). Property type: Combination of industrial and commercial space Purchase price: $500,000 First mortgage loan: $200,000 Amount the buyer can come up with: $100,000 Shortfall: $200,000 There are very few banks or lending institutions that are willing to give anyone a $200,000 second mortgage. Banks generally do not like second mortgages on commercial properties. This is the perfect opportunity for an ME loan. An ME lender can step in and come up with the $200,000 needed to make the deal happen. The examples listed above are just a few of many. There is no typical loan amount in today's ME market. A loan can range from $50,000 up into the millions and beyond, as long as a property is held in the name of a corporation. The only other thing that you need to know is that to fit the ME profile, a property must be a good value with positive rates of return. Vacant properties and properties in bad condition are generally not the typical ME deal, even though they may be considered on a case-by-case basis. Don't even consider a single-family house or a property that the borrower wants to live in. Also, two- to four-family properties won't fly either. ME programs typically deal with eight-family properties and up or medium to large commercial or industrial properties. If your eyes aren't popping out of your head at the amazing number of possibilities, please read the article again. Either I didn't write it clearly enough or you didn't get it. I'll repeat it again. An investor can buy commercial or multi-unit residential properties borrowing both a mortgage and a down payment. If you start to say to yourself, "No bank would allow an ME second mortgage behind the primary mortgage," don't worry so much. Some ME lenders may offer the borrower the first mortgage, as well as the ME second. This should really open the door for you to look at financing bigger commercial properties, without having to worry about where the buyer is going to get all of the cash to use as a down payment. Don't jump up and down too much. These types of loans are not cheap. The lenders certainly charge for these amazing deals, but they still enable investors to do unbelievable things without using up all of their own cash. Yes, detailed rates and terms are determined on a case-by-case basis, and it's not uncommon for the lender to charge high rates and points or simply a low rate, but the lender will take an equity portion of the property in either case. It's also not uncommon for the lender to look for additional collateral from the borrower. It used to be that big profit investing was only for the very rich. After all, a down payment on a property worth $1 million or more is a lot of money—more than most people can handle. This really levels the playing field and lets the smaller investor compete (and lets you arrange the financing). Ari Miller is vice president of Gelt Financial Corporation, a private portfolio lender based in Southampton, Pa. He may be reached at (215) 357-4955, ext. 275 or e-mail [email protected]
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