Both mezzanine debt and preferred equity fill the gap between senior debt and common equity in the capital stack, but they differ structurally. Mezzanine debt is a loan — it accrues interest, has a maturity date, and is secured by a pledge of the borrower's ownership interests. Preferred equity is an equity investment that sits above common equity and receives a priority return before the common equity holders.
Quick Comparison
Key attributes side by side.
| Attribute | Mezzanine Debt | Preferred Equity |
|---|---|---|
| Position in Capital Stack | Between senior debt and equity | Between mezzanine debt and common equity |
| Security / Collateral | Pledge of borrower's ownership interests in the property-owning entity | No lien; contractual equity rights within the operating agreement |
| Typical Term | 2-5 years, co-terminus with senior debt | 2-5 years or aligned with hold period |
| Cost / Rate Range | 10-18% interest (current pay + accrual) | 10-18% preferred return + potential equity upside |
| Risk Profile | Subordinate to senior debt; higher risk than senior, lower than equity | Junior to all debt; higher risk but with priority over common equity |
| When to Use | When the senior lender permits subordinate debt and you want a fixed obligation | When the senior lender restricts additional debt or you want to avoid adding a loan |
| Foreclosure / Remedy | UCC foreclosure on ownership interests; can take control of the entity | Forced sale, management replacement, or buyout provisions per operating agreement |
In Depth
Mezzanine debt is a loan that sits behind the senior mortgage in the capital stack. It is secured not by a lien on the real property itself, but by a pledge of the borrower's membership or partnership interests in the entity that owns the property. This structure allows mezzanine lenders to foreclose via a UCC sale rather than a judicial foreclosure, which is typically faster and less expensive.
Mezzanine loans generally carry interest rates between 10% and 18%, with a combination of current-pay interest and deferred or accrued interest. Terms are typically 2-5 years and are co-terminus with or subordinate to the senior mortgage. The mezzanine lender and senior lender enter into an intercreditor agreement that governs cure rights, standstill periods, and foreclosure procedures.
Because mezzanine debt is structured as a loan, the interest payments are generally tax-deductible for the borrower. The mezzanine lender's returns are more predictable and capped — they receive their interest rate but do not participate in the upside of the deal. This makes mezzanine debt appealing when the sponsor wants to maximize leverage without diluting equity returns.
In Depth
Preferred equity is an investment in the ownership structure of the property-owning entity. The preferred equity investor receives a priority return — paid before any distributions to common equity holders — but sits junior to all debt in the capital stack. Preferred equity is not secured by a lien or a pledge; instead, the investor's rights are governed by the operating agreement.
Preferred equity returns typically range from 10% to 18% as a preferred return, and may also include an equity kicker or profit participation that gives the preferred equity holder a share of the upside. This makes preferred equity more expensive than mezzanine debt in deals that perform well, but potentially cheaper if the deal underperforms since there is no mandatory debt payment.
One significant advantage of preferred equity is that it often does not trigger intercreditor issues with the senior lender. Many senior lenders restrict subordinate debt but permit preferred equity because it is structured as equity rather than a loan. This can be the deciding factor in capital structure decisions, particularly with agency lenders (Fannie Mae, Freddie Mac) or CMBS loans that prohibit subordinate financing.
Key Differences
Legal structure: Mezzanine is a loan with a promissory note; preferred equity is an equity investment governed by the operating agreement.
Security: Mezzanine is secured by a pledge of ownership interests; preferred equity has no collateral security.
Remedy on default: Mezzanine lenders foreclose via UCC sale; preferred equity investors enforce rights through operating agreement provisions (forced sale, management takeover).
Senior lender treatment: Many senior lenders restrict subordinate debt but allow preferred equity, making pref equity viable when mezz is not.
Tax treatment: Mezzanine interest is tax-deductible for the borrower; preferred equity returns are treated as partnership distributions.
Upside potential: Mezzanine lenders receive fixed interest only; preferred equity investors may share in deal upside through equity participation.
Intercreditor requirements: Mezzanine requires an intercreditor agreement with the senior lender; preferred equity typically does not.
Decision Guide
Practical scenarios to help you decide.
Our Role
H Equities provides both mezzanine loans ($3MM-$15MM) and preferred equity ($3MM-$15MM), so we can help you determine the right structure for your deal. We work closely with senior lenders and understand intercreditor dynamics, ensuring your capital stack is structured efficiently from day one.
FAQ
Preferred equity is generally considered riskier for the investor because it has no collateral security and sits lower in the capital stack. However, preferred equity investors may receive upside participation that compensates for this additional risk.
It is uncommon but possible. In practice, most sponsors choose one or the other to fill the gap between senior debt and common equity. Using both would add complexity and is typically only seen in very large transactions.
Senior lenders restrict subordinate debt because it adds mandatory payment obligations that compete with their debt service. Preferred equity, being structured as equity, does not create a competing lien or mandatory payments, so senior lenders view it as less risky to their position.
An intercreditor agreement is a contract between the senior lender and the mezzanine lender that governs their respective rights, cure periods, standstill provisions, and foreclosure procedures. It is required for mezzanine debt but typically not needed for preferred equity.
A UCC foreclosure allows the mezzanine lender to seize the borrower's ownership interests in the property-owning entity, effectively taking control of the property without going through judicial foreclosure. This process is typically faster (weeks vs. months) and less costly than mortgage foreclosure.
Related
Tell us about your transaction and we'll help you identify the right financing structure — bridge, mezzanine, preferred equity, or co-GP.