What is the risk profile associated with mezzanine loans?

Mezzanine loans are a type of financing that occupies a middle position between senior debt and equity in the capital structure of a real estate investment. They are inherently higher risk due to several factors.

First, mezzanine loans are subordinate to senior debt, meaning that in the event of a default, mezzanine lenders are repaid only after senior lenders have been satisfied. This position in the capital structure naturally increases the risk to mezzanine lenders because they may not get full repayment if the project's revenue or value declines.

Second, these loans often come with fewer covenants and may be used for more speculative investments, requiring a lender to assess not just the property's value but also the borrower's ability to generate returns that exceed the cost of the mezzanine financing.

Additionally, the potential for higher yields reflects this risk; mezzanine loans typically carry higher interest rates compared to senior loans. Lenders seek compensation for the increased risk of default. This yield can make them an attractive option for investors looking for higher returns that come with the acceptance of greater risk.

Overall, the characteristics of mezzanine loans—a blend of debt and equity traits, their subordinated status, and the potential returns—validate the classification of these loans as higher risk, higher yield investments.