Mezzanine debt explained: how the middle layer of the capital stack works

Mezzanine debt is a layer of borrowing that sits between a senior loan and the borrower's own equity. The name comes from architecture: the mezzanine is the floor between two others, and mezzanine finance occupies exactly that position in the capital structure. For a property developer it is the piece that turns a scheme you could only part-fund into one you can actually build.

We are a principal mezzanine lender, so we underwrite this layer from our own book. Where a case suits another funder better, we arrange it whole of market. Either way, the mechanics below are the same.

What is mezzanine debt?

Mezzanine debt is a subordinated loan that ranks behind senior debt but ahead of equity for repayment. It is a hybrid: priced and documented like debt, but carrying some of the risk profile of equity because of where it sits. In a development, the mezzanine lender advances funds that top up the senior facility, and takes a second charge over the site as security. The developer gets more of the project cost funded; the lender accepts a lower priority claim in exchange for a higher rate.

The consensus definition across the market is consistent. Mezzanine finance fills the gap between the debt a senior lender will provide and the total cost of a project, without the developer having to write a cheque for that whole gap in cash. It is used in property development, in corporate finance for mergers and acquisitions, and in management buyouts. Our focus is property: we do not fund corporate mezzanine, and the two behave differently, which we explain below.

Where mezzanine sits in the capital stack

The capital stack is the order in which each layer of funding is repaid. From the bottom (paid first, lowest risk) to the top (paid last, highest risk) a typical development stack runs:

• Senior debt. The largest layer, first charge, first to be repaid. Indicatively 55 to 70 percent of cost.
• Mezzanine debt. The middle layer, second charge, repaid after senior. Indicatively 15 to 30 percent of cost.
• Equity. The developer's own capital, last to be repaid and first to absorb any loss.

Some structures insert preferred equity between mezzanine and common equity. We compare those in our guide to preferred equity versus mezzanine, and the full picture is set out in the capital stack in property development.

Mezzanine debt vs senior debt

The difference between senior debt and mezzanine debt is priority. Senior debt holds the first charge and is repaid before anything else; mezzanine holds a second charge and is repaid only once the senior lender is whole. That single fact drives everything else. Because the senior lender is protected first, it lends at a lower rate. Because the mezzanine lender waits behind it and could lose capital if a sale falls short, mezzanine is priced higher.

All figures indicative; every facility is priced case by case.

Mezzanine debt vs junior and subordinated debt

In practice the terms overlap. Junior debt and subordinated debt both describe any borrowing that ranks behind senior debt, and mezzanine debt is one form of subordinated debt. The distinction is that mezzanine is a specific, structured product with its own charge and intercreditor position, whereas subordinated debt is the broader category. In property development the layer behind the senior loan is almost always called mezzanine; in corporate finance you will more often hear junior or subordinated debt, sometimes carrying equity warrants that a property mezzanine loan would not.

How mezzanine debt is secured

Mezzanine debt is secured by a second charge over the development, registered behind the senior lender's first charge. If the borrower defaults and the site is sold, the senior lender is repaid in full first, and the mezzanine lender is repaid from what remains. Alongside the charge, a mezzanine lender will usually take a personal guarantee from the developer, a debenture over the special purpose vehicle that holds the site, and the benefit of an intercreditor agreement with the senior lender that governs how the two lenders behave. We cover that document in detail in our guide to intercreditor agreements.

Corporate mezzanine vs property development mezzanine

Corporate mezzanine funds a business: it supports a buyout or an acquisition, is repaid from the company's cash flow over several years, and frequently carries warrants or an equity kicker that give the lender an upside if the business grows. Property development mezzanine funds a building: it is drawn down as construction proceeds, is repaid in a single event when the scheme sells or refinances, and is secured against the land and works rather than a trading business. We lend against property. If your requirement is corporate, the structures on this page will not map cleanly onto it.

What mezzanine debt costs, and why

Mezzanine is priced indicatively from 12 percent a year, often in the 12 to 18 percent range, plus an arrangement fee of around 1.5 to 2.5 percent. Interest is usually rolled up rather than paid monthly, so it accrues and is settled at exit, which keeps cash inside the project during the build. That headline rate looks steep next to senior debt, but it is charged on the smaller middle slice of the stack. The number that matters is the blended cost across the whole structure, which usually lands close to 10 percent a year at high leverage. You can model this on our mezzanine leverage calculator.

How mezzanine debt is drawn down and repaid

In development finance, mezzanine debt is not handed over in a lump at the start. It is drawn down in stages as the build progresses, usually alongside the senior facility and in an order fixed by the intercreditor agreement. Interest is typically rolled up, meaning it accrues on the drawn balance and is settled at the end rather than serviced monthly, which keeps cash inside the scheme while there is no income coming in. Repayment happens at a single exit: the loan is cleared when the finished units sell or when the completed scheme is refinanced onto longer-term debt. Because everything hinges on that one event, a mezzanine lender will scrutinise the exit strategy as hard as the build itself. A scheme with strong construction fundamentals but a weak or slow route to sale is exactly the profile a mezzanine lender worries about, because it is repaid only once practical completion is reached and the units start to move.

Why is mezzanine debt risky?

Mezzanine debt is risky because of its position, not because the projects are bad. It ranks behind senior debt, so in a shortfall the senior lender is made whole before the mezzanine lender receives anything, and the developer's equity absorbs the first loss below that. If a scheme sells for less than expected, the mezzanine layer can be the one that takes the hit. That subordination is the reason the rate is higher: the lender is paid for waiting in the queue. For the developer, the risk is leverage. Borrowing more of the cost magnifies return on equity when a scheme goes well and magnifies the pain if it does not. It is a tool for experienced developers with a real margin, not a way to rescue a thin deal.

An example of a mezzanine loan

Consider an illustrative £5m development. A senior lender offers 65 percent of cost, which is £3.25m, and takes a first charge. The developer has £500k of equity to commit. That leaves a £1.25m gap. A mezzanine loan of £1.25m, a further 25 percent of cost, closes it: the developer builds the scheme with £500k in rather than the £1.75m the senior facility alone would have required. The mezzanine lender takes a second charge, rolls up interest at an indicative 15 percent a year, and is repaid after the senior lender when the finished units sell. If the scheme makes its numbers, the developer has freed up more than £1m to put into the next site. That is the whole point of the middle layer.