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Leveraged Breakdowns

REPE Interview Prep: Debt Seniority, CMBS, and Recourse


Leveraged Breakdowns teaches real estate private equity for beginners. That’s why we provide materials such as our flagship course Breaking Down REPE and even our free real estate private equity case study. This particular series focuses on the types of questions you might face during a real estate private equity interview. Today’s lesson focuses on debt, namely: seniority, CMBS, and recourse. We suggest you practice these questions as if you were responding during a live interview. Don’t just memorize, but understand why each response makes sense.

What is the difference between a senior loan and a mezzanine loan? Why do investors frequently use both on a single deal?

First, you will usually only see mezzanine loans in opportunistic deals because of the risk profile. A senior loan is the loan that has seniority in terms of collateralization. Often this is a bank or CMBS loan that is secured by a first lien on the subject property. Because the loan is secured, there is less risk and the interest rate is the lowest in the capital stack, usually 200-400 basis points above the like treasury.

A mezzanine loan is another form of debt, but is either collateralized secondary to the senior loan or is unsecured altogether, and repayment is secondary behind the senior lender.  As a result, it carries a higher interest rate, often 500-1,000 points above the like treasury. The mezzanine loan has priority of payment ahead of equity, so it has less risk than equity, but more risk than senior debt. Investors will use mezzanine loans because the rates are lower than expected equity returns for opportunistic deals, which usually start at 20%. Mezzanine loans, then, lower the overall cost of capital for a deal and help boost returns to the equity investors.

What do you think are the best kind of deals to finance with CMBS debt?

Any property with less than 70% leverage, average lease term longer than the proposed loan term, a hold period longer than the loan term, and tenants with national credit. If you have all of these, you have a good candidate for a CMBS loan. Most often, assets that will qualify for CMBS loans will be Core or Core-Plus, or potentially a Value-Add deal that just signed the last few leases needed to stabilize the property, and the owner plans to hold for the long term. Since CMBS loans are expensive to break, you don’t want to put them in place on a project you have plans to exit before the loan matures.

What are the differences between recourse and non-recourse senior debt?

The primary distinction is that a recourse loan requires a guaranty from a financially capable person or entity as additional security for the lender, where a non-recourse loan does not include any such guaranty. Commercial banks are typically recourse lenders, but if the LTV of the property is low enough, usually 60% or less, non-recourse debt from a bank is possible. CMBS and Life Insurance financing is usually non-recourse, but the LTV requirement is 60% or less.

Need to learn quickly?

If you have an upcoming real estate private equity case study, we recommend you start with our REPE Starter Kit. It teaches real estate private equity for beginners who are under a time crunch to get as smart as possible as quickly as possible. Otherwise, check out our blog for plenty more articles that quickly take you from zero to REPE hero.

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