Senior debt (the first mortgage) occupies the safest position in the capital stack, secured by a direct lien on the property with priority over all other claims. Mezzanine debt sits above senior debt in risk, secured by a pledge of the borrower's ownership interests rather than the property itself. Senior debt offers lower rates (5.5-8%) while mezzanine carries higher rates (10-18%) to compensate for its subordinate position.
By H Equities. Numerical examples and rate ranges are educational illustrations, not current financing quotes.
Reference: OCC Commercial Real Estate Lending handbook. Actual rights and obligations depend on the transaction documents.
Quick Comparison
Key attributes side by side.
| Attribute | Senior Debt | Mezzanine Debt |
|---|---|---|
| Position in Capital Stack | First priority, bottom of the stack, lowest risk | Second priority, between senior debt and equity |
| Security / Collateral | First lien mortgage on the real property | Pledge of borrower's membership/partnership interests |
| Typical Term | 5-10 years (bridge: 1-3 years) | 2-5 years, co-terminus with senior debt |
| Cost / Rate Range | 5.5-8% (permanent) or 8-12% (bridge) | 10-18% interest (current pay + accrual) |
| Risk Profile | Lowest risk in the capital stack; first to be repaid | Higher risk; subordinate to senior debt, repaid second |
| When to Use | Every CRE transaction: the foundation of the capital stack | When senior debt alone does not provide sufficient leverage |
| Foreclosure / Remedy | Mortgage foreclosure (judicial or non-judicial) | UCC foreclosure on ownership interests |
In Depth
Senior debt, typically structured as a first mortgage, is the foundational layer of any commercial real estate capital stack. It holds the highest priority claim on the property, meaning the senior lender is repaid first in the event of liquidation. This priority position makes senior debt the lowest-risk component of the capital stack, which is reflected in its lower interest rates.
Senior lenders provide 50-75% of the property's value (loan-to-value or LTV), depending on the asset type, market, and property condition. Banks, life insurance companies, CMBS conduits, and agency lenders (Fannie Mae, Freddie Mac) are the primary sources of senior debt. Underwriting is rigorous, focused on debt service coverage ratio (DSCR), LTV, borrower creditworthiness, and property cash flow.
The senior lender's security interest, a mortgage recorded against the property, gives it the right to foreclose on the real estate if the borrower defaults. This is the most powerful form of collateral in CRE lending and is why senior debt commands the lowest cost of capital in the stack.
In Depth
Mezzanine debt fills the gap between the senior mortgage and the sponsor's equity, typically providing an additional 10-20% of the capital stack. For example, if the senior lender provides 65% LTV, a mezzanine loan might cover 65-80% of the total capital, with the sponsor contributing the remaining 20% as equity.
Mezzanine loans are secured not by a mortgage on the property, but by a pledge of the borrower's ownership interests in the property-owning entity. This allows the mezzanine lender to foreclose via a UCC sale, seizing the borrower's LLC or partnership interests, rather than going through the longer mortgage foreclosure process. The mezzanine lender and senior lender enter into an intercreditor agreement that governs their respective rights.
Interest rates on mezzanine debt range from 10% to 18%, reflecting its subordinate position. If the property is sold or liquidated, the senior lender is repaid in full before the mezzanine lender receives anything. This subordination risk is why mezzanine debt costs significantly more than senior debt. However, mezzanine financing allows sponsors to increase leverage and potentially boost equity returns without diluting ownership.
Key Differences
Priority: Senior debt is repaid first in all scenarios; mezzanine is repaid only after senior debt is fully satisfied.
Collateral: Senior debt holds a mortgage on the real property; mezzanine is secured by a pledge of ownership interests.
Cost: Senior debt costs 5.5-12%; mezzanine costs 10-18%.
LTV: Senior debt covers 50-75% of value; mezzanine fills the gap to 75-85% total leverage.
Foreclosure process: Senior lenders use mortgage foreclosure; mezzanine lenders use UCC foreclosure on ownership interests.
Lender types: Senior debt comes from banks, insurance companies, CMBS, and agencies; mezzanine comes from debt funds, specialty lenders, and private capital.
Intercreditor: Mezzanine requires an intercreditor agreement with the senior lender; senior lenders have ultimate control.
Decision Guide
Practical scenarios to help you decide.
Going deeper
On a $40 million acquisition, illustrative figures throughout, senior debt alone at 65% LTV provides $26 million at an illustrative 7% rate, leaving the sponsor to fund $14 million of equity, roughly 35% of the deal, to close.
Layering mezzanine debt behind that same senior loan changes the math: the senior lender still provides $26 million at 7%, and a mezzanine lender adds another $6 million at an illustrative 13% rate, bringing total leverage to 80% and shrinking the required equity check to $8 million. The blended cost of debt rises from a flat 7% to roughly 8.1%, but the sponsor now needs $6 million less equity, which can meaningfully improve the equity return if the deal performs as projected, and meaningfully worsen it if the deal underperforms, since more of the capital stack now carries a fixed obligation.
Senior debt is documented through a mortgage or deed of trust recorded against the real property, a promissory note, and, for larger loans, a loan agreement with standard financial covenants tested against the property's actual performance. This is the most straightforward security instrument in commercial real estate: the senior lender's claim runs directly against the asset.
Mezzanine debt adds a second, separate document set on top: a note secured by a pledge of the borrower's ownership interests, a UCC-1 filing rather than a mortgage, and critically, an intercreditor agreement between the senior and mezzanine lenders that spells out cure periods, standstill provisions, and who acts first if the loan defaults. Sponsors layering mezzanine behind senior debt should expect the intercreditor negotiation to add real time and legal cost to closing beyond what a senior-only deal would require.
At acquisition, the leverage decision is largely about how much equity the sponsor and its investors want to commit relative to the projected return. Mid-hold, added mezzanine debt service becomes a real test of whether the property's actual cash flow, not the pro forma, can support the combined senior and mezzanine payment without drawing down reserves.
Approaching refinance or sale, the mezzanine loan's co-terminus maturity with the senior loan means both must be addressed together, and a property that has not appreciated or stabilized as projected can find itself needing to refinance more debt than a senior-only structure would have required, with less cash flow cushion to do it.
Adding a mezzanine layer is a leverage decision as much as a financing decision, and it deserves the same scrutiny as any other choice that changes the deal's risk profile.
Senior debt and mezzanine debt are designed to combine; that layering is the entire purpose of mezzanine financing. The senior loan is sized first against the property's value and cash flow, and the mezzanine loan fills the gap up to a higher combined leverage point, with the sponsor contributing the remaining equity. H Equities provides both senior bridge loans and mezzanine financing and can structure either layer or the combined stack depending on how much leverage a given deal and sponsor can support.
Our Role
H Equities provides both senior bridge loans ($5MM-$50MM) and mezzanine financing ($3MM-$15MM). We understand how these layers interact and can help you structure the optimal capital stack for your deal, whether that means a single senior loan or a layered senior + mezzanine structure.
FAQ
Mezzanine debt is almost always layered behind senior debt. It fills the gap between the senior mortgage and equity. Standalone mezzanine lending without a senior loan in place is extremely rare in commercial real estate.
Yes. Mezzanine debt increases the total leverage on the property, which amplifies both potential returns and potential losses. If the property underperforms, the additional debt service from the mezzanine loan can strain cash flow and increase the risk of default.
If the senior lender forecloses on the property, the mezzanine lender's security (the ownership interests) becomes worthless because the entity no longer owns the property. Mezzanine lenders mitigate this risk through intercreditor agreements that give them cure rights and standstill periods.
Mezzanine loans typically range from $2MM to $25MM, depending on the deal size. They usually represent 10-20% of the total capital stack. H Equities provides mezzanine loans from $3MM to $15MM.
Yes. Because mezzanine debt is structured as a loan, the interest payments are generally tax-deductible for the borrower, similar to senior debt interest. This is one advantage of mezzanine debt over preferred equity, where returns are treated as partnership distributions.
Related
Tell us about your transaction and we'll help you identify the right financing structure: bridge, mezzanine, preferred equity, or co-GP.