Multifamily Short-term Mezzanine Debt & Bridge Loans - What?

[Joseph Firmin]

I read this statement in the M&M report for 2019 as I'm doing research to zero in on markets to invest in for multifamily: "Lenders have been reluctant to lend on future revenue growth through value-add efforts, resulting in increased use of short-term mezzanine debt and bridge loans to cover the span until improvements deliver the planned returns."

Can someone be so kind as to explain the two bolded terms for me and how to use them effectively when purchasing a multifamily asset? Thank you! - Joe

[Kevin Dean]

@Joseph Firmin

In addition to what has already been said, I wanted to point out one way that mezzanine debt can effect returns, and in the process hopefully further answering your question "How to use mezzanine debt effectively when purchasing a multifamily asset?"

As mentioned above, investors will often use mezzanine debt to fill the gap between the equity needed to close, and the equity on hand. While that is true, mezzanine debt may also be used by an investor in order to boost returns. If the cost of the mezzanine debt is less than the cost of the equity partners, for example, if equity partners demand a 15% return, and you are able to secure mezzanine debt at 10% to fund some of the "capital stack", your overall return to the equity investors will be increased as the overall return requirement is lowered and the total equity needed to close is reduced. This math equation is why using leverage to purchase real estate increases returns (when done properly of course).

So, if you use mezzanine debt effectively, you may be able to either deliver a higher return to your equity partners, or you may be able to pay more up front for the property, and return the same targeted return to your investors.

Because everything I have mentioned so far has only highlighted the positives of utilizing mezzanine debt, one word of caution...over-leveraging an asset can definitely result in lower returns, negative cash flow, inability to refinance at the end of your loan term and can also result in default. As is always the case when utilizing debt, err on the side of conservatism. Luckily banks don't want you to default on your loan either, so they will pull back when necessary, but just remember they're not looking at your investor returns as closely as you are.