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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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