Investing Ideas
Finding extra yield potential in real estate mezzanine debt
Explore the potential for attractive risk-adjusted returns in a misunderstood part of the market, real estate mezzanine debt.
Key Takeaways
- There are two main ways to approach the high yield real estate debt market: synthetic mezzanine (levered whole loan), and direct mezzanine (unlevered).
- Synthetic mezzanine structures carry margin call risk. In a Synthetic mezzanine structure, mortgage lenders manufacture high yield returns by setting up leverage facilities with banks in an arrangement called a repurchase agreement. In addition to getting paid interest, the bank also puts covenants in the repurchase agreements whereby they can issue margin calls under certain conditions. Historically, as capital markets volatility increases and economic activity slows down, there is increased risk of banks issuing margin calls which has a detrimental impact on returns for the synthetic mezzanine lenders.
- Direct mezzanine debt has a credit risk profile similar to synthetic mezzanine without the margin call risk. Direct mezzanine lenders shop the market to find the most efficient senior lender. Combining mezzanine debt with the senior loan results in a cost-effective loan for the borrower and yield on the direct mezzanine debt that is higher than the synthetic counterpart.
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Finding extra yield potential in real estate mezzanine debt
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