Commercial real estate transactions frequently involve layered capital structures where the gap between senior mortgage debt and the sponsor's equity is filled by mezzanine debt or preferred equity. These instruments allow sponsors to maximize leverage and reduce their required equity investment, while investors earn yields higher than senior mortgage rates in exchange for accepting subordinated risk.
CRE mezzanine debt is a loan secured not by a mortgage on the property itself, but by a pledge of the equity interests in the entity that owns the property. This indirect security interest is enforceable through Uniform Commercial Code (UCC) foreclosure proceedings, which are faster than mortgage foreclosure in many states. Mezzanine lenders stand behind the senior mortgage lender — they are repaid only after the senior mortgage is fully retired — and in a distress scenario, mezzanine lenders can foreclose on the borrower's equity and assume control of the property-owning entity.
Preferred equity is structurally similar to mezzanine debt in terms of its position in the capital stack, but it takes the legal form of equity rather than debt. Preferred equity holders receive a priority return (an "accruing preferred return") ahead of the common equity sponsor, and they typically have governance rights — the ability to replace the property manager, approve budgets, or force a sale — if the preferred return is not paid or if the business plan is not being executed as agreed. The line between mezzanine debt and preferred equity can be blurry; both serve similar economic functions.
Intercreditor arrangements between senior mortgage lenders and mezzanine lenders are governed by intercreditor agreements (often called "snooze-you-lose" agreements). Senior lenders typically impose standstill periods on mezzanine enforcement, restrict mezzanine lenders from interfering with the senior lender's relationship with the borrower, and grant senior lenders the right to purchase the mezzanine loan before mezzanine lenders can exercise remedies.
Pricing for CRE mezzanine debt typically ranges from 10–15%+ depending on the transaction, with preferred equity commanding similar or higher rates. These rates reflect the subordinated position, the illiquidity of the instrument, and the complexity of enforcement. For sponsors, the total blended cost of the capital stack — senior mortgage plus mezzanine or preferred equity — must be justified by projected returns on the completed, stabilized property.