Mezzanine & Preferred Equity: Filling the Gap

Many CRE deals need more capital than one single lender is willing to provide. If your client is short on equity, mezzanine financing or preferred equity may bridge the gap between what the senior lender offers and the total project cost.

While these capital sources look similar on the surface, they behave differently — and it’s your job as a broker to help your client understand which (if either) makes sense. The following guide is part of our longer, comprehensive walkthrough of all CRE loan types.

What Is Mezzanine Financing?

Mezzanine debt is a junior loan that sits behind the senior mortgage. It usually comes with a higher rate and fewer protections than the senior loan, but more structure and formality than equity. In most cases, the lender will secure its position with a pledge of the borrowing entity’s ownership interest — not a lien on the property itself.

Because it’s subordinate to the first mortgage, the senior lender must approve the mezz loan and agree to an intercreditor agreement. Note that some lenders will flat-out refuse to allow mezzanine financing (and many types of senior debt, like HUD multifamily loans, won't allow it regardless).

Use cases include ground-up construction, value-add projects, or acquisitions where the borrower is short on equity but has a clear path to refinancing or sale.

What Is Preferred Equity?

Preferred equity is not a loan — it’s an investment. A preferred equity provider contributes capital in exchange for a return, but doesn’t take a direct ownership stake like a common equity partner. Instead, they sit above common equity in the waterfall and usually receive a fixed or targeted return before any other distributions are made.

Unlike mezzanine debt, preferred equity doesn’t require lender approval in all cases — but it depends heavily on how it’s structured. If it includes lender-like remedies (like the right to take control of the asset), the senior lender may treat it just like mezz, requiring approval and documentation.

Preferred equity can be a flexible tool, but the line between debt and equity can blur fast.

Deciding Between the Two

Let's go through a hypothetical example. A borrower is acquiring a $20 million multifamily asset and secures $14 million in senior debt. They need another $4 million to complete the capital stack after bringing $2 million of their own equity.

They first consider mezzanine debt — but their senior lender refuses to allow it due to policy restrictions. Instead, they secure a preferred equity investment with a fixed 10% preferred return and a small share of upside. The pref equity doesn’t trigger senior lender objections because it’s structured passively, without foreclosure rights. It’s slightly more expensive than mezz would’ve been — but it gets the deal done without jeopardizing the senior loan.

Key Differences to Know

• Security: Mezz is typically secured (via pledge of equity); pref is not, unless structured aggressively.
• Remedies: Mezz lenders can foreclose on the borrower’s equity. Pref equity holders may have contractual remedies, but can’t always enforce them like a lender.
• Returns: Mezz usually has a fixed interest rate. Pref equity may be structured with a preferred return, participation, or both.
• Lender consent: Mezz always requires it. Pref sometimes does.
• Legal structure: Mezz is a loan; pref is part of the ownership stack.

When to Use Each

Use mezzanine financing when:

• The borrower has limited equity but a strong business plan
• Senior debt is already maxed out
• The sponsor is comfortable with more leverage and understands the risks

Use preferred equity when:

• There’s a need for flexibility in structure
• A true equity partner isn’t viable or desirable
• The borrower wants to avoid lender approvals (where possible)

Broker Tips

• Understand the full capital stack before placing a deal
• Talk to the senior lender early — their attitude toward mezz and pref matters a lot
• Make sure your borrower understands dilution, remedies, and exit mechanics
• Work with legal counsel to review intercreditor or joint venture agreements
• Pref equity can trigger surprises if it’s not documented cleanly — so stay ahead of it

Wrapping It Up

If the deal needs more capital than senior debt provides, mezz or preferred equity might work. Just make sure the borrower understands what they’re signing up for — and who holds the power when things get bumpy.