Over the past few years, the real estate cycle in the United States has matured enough that real estate investors are, once again, considering mezzanine debt and preferred equity investments. We, as lawyers, witnessed similar interest in the previous cycle, but investing in the middle of the capital stack went out of favor with the arrival of the credit crisis. This article compares mezzanine debt and preferred equity investments, and describes how to understand, identify and mitigate risk in investing behind a mortgage lender, while also not taking the “first dollar” of losses that a common equity investor would.

Leverage can enhance returns to equity. Sponsors will seek mezzanine debt and preferred equity to decrease the amount of common equity in a particular asset-level capital stack. Most mortgage lenders will not loan more than 55 percent to 65 percent loan to value. Some real estate investors want to further enhance returns to equity more than traditional mortgage