Risks and Realities of Mezzanine Loans

Abstract

The last decade has witnessed an astounding increase in new real estate financing techniques, including mezzanine loans. These new financings are not directly secured by real estate and do not even directly involve land. In the real estate industry, mezzanine financing typically refers to a loan secured principally by the borrower\u27s equity in other entities. Both economically and legally, the value of the mezzanine borrower\u27s collateral derives solely from its indirect ownership of the underlying property. This article provides a detailed description of the legal structure of mezzanine loans. In addition, this article evaluates the hazards, legal risks and uncertainties inherent in mezzanine financings and the way in which the market fails to adequately take these factors into account. This article shows that mezzanine lenders face significant risks both at the origination of their loans and later on if there is an event of default. At loan origination, lenders are faced with complex rules for the creation, attachment and perfection of liens on their collateral. Later on, a mezzanine lender is faced with other risks if the mezzanine borrower defaults and the lender must actually foreclose upon its collateral. In this article, Professor Berman also argues that the recent subprime mortgage crisis offers a cautionary tale for many of the hazards that may be looming in the near future for the mezzanine loan market, that mezzanine lenders must better understand and evaluate these hazards, and that the legal system needs to produce clearer rules on these non-traditional financings. In particular, Professor Berman contends that mezzanine lenders ought to proceed with caution - to tighten up their underwriting standards, strengthen their loan documentation, and review the ready availability of capital to questionable projects