Author: Charlie Pihart
Topic: Mezzanine Debt Growth
Since the 2008 financial crisis, regulators have imposed stricter capital requirements on banks. As a result, traditional lenders have chosen a more risk-averse path, leading to lower loan-to-value (LTV) ratios across the traditional lending board. This has led to notable growth in private credit markets, a trend that isn’t likely to slow down any time soon. According to Morgan Stanley’s 2024 Private Credit Outlook, the private credit market is projected to grow to a staggering $2.8 trillion by 2028, a significant increase from the 2024 $1.5 trillion market, which was already an increase from the 2020 $1 trillion market. Additionally, current market conditions, most notably high interest rates, have resulted in an increase to the overall cost of debt, making typically more expensive private debt relatively less expensive than before compared to higher rate traditional loans. This reality has resulted in an increased demand for mezzanine debt, providing private lenders with a unique opportunity.
It’s important to note that private credit is unregulated capital, currently a sort of ‘wild west’. As Howard Marks, co-founder of Oaktree Capital Management, explains in the April 7, 2025 podcast episode of “Capital Allocators”, private credit is the most recent addition in the alternative investment world. Historically, the market has acted in cycles, resulting in new ways to invest, alternative investments, and adaptation. As explained in the same podcast episode above, the below graphic explains the timeline of previous market cycles and how we’ve gotten to where we are today.
Mezzanine Debt Overview
Mezzanine debt, or “mezz debt,” is subordinate debt or a second loan that increases total LTV and decreases the total amount of equity needed for a project. Because of the subordinate position to senior debt, mezz debt carries a higher risk, resulting in a demand for higher returns. This debt is typically issued by private lenders (private credit funds, business development companies, mezzanine-specific debt funds, or private equity backed credit arms). These loans demand higher rates than senior debt but are secondary in priority regarding payment (senior debt is paid first, then mezz debt, then equity payouts). Mezz financing essentially bridges the gap between debt provided by senior lenders and the equity a sponsor is willing and/or able to raise.
Preferred equity, by contrast, is an equity investment that sits below all debt (including mezz) and doesn’t require regular payments. Instead, it pays distributions only when the project performs and has no collateral rights, but may offer more upside. Preferred equity is different from common equity in that it has priority in payouts but usually no voting rights. Preferred equity holders receive fixed dividends before common shareholders get anything, but they typically don’t participate in the full upside like common equity holders do. Preferred equity sits in the middle, less risky than common equity, but with less control and upside. The capital stack figure below shows an example (in real estate) of priority and returns.
From the perspective of the mezz lender, it’s possible to get significant returns, higher than senior debt rates and sometimes even higher than equity investors. This is important because mezz debt has a higher priority (lower risk) than equity payouts. It’s not uncommon for mezz debt to carry interest rates in the mid to high teens, sometimes even greater than twenty percent. Sponsors are willing to pay such a high price because it’s still cheaper than raising additional capital. This gives sponsors the ability to use their saved equity in other areas, increase their total return on equity, or do deals they otherwise wouldn’t have had the total equity to do.
Mezz debt is used by borrowers who’ve usually already exhausted the maximum senior debt possible but want to avoid diluting equity. Currently, mezz debt has provided a significant opportunity to borrowers, specifically in real estate, LBOs, corporate expansion, and major infrastructure/energy projects. In all cases, mezz debt fills a major financing gap left by the lower LTVs of senior debt.
With this in mind, mezz debt can carry significant risk. Because of the subordinate position, in a default, the mezz lender will only recover value after the senior debt is paid off. This may result in mezz capital being completely wiped out if the value only covers the senior debt. Mezz debt is typically unsecured, unlike senior debt, meaning it’s not backed by specific collateral and instead only backed by the cash flows of the asset. Additionally, senior lenders aren’t always comfortable with equity investors using mezz debt on top of their loan, as a major reason they originally lent a lower LTV loan was so equity investors would put up significant equity to prove they have skin in the game, reducing risk. Senior loan agreements are well within their rights to restrict additional borrowing within the original loan terms, sometimes resulting in less favorable terms for mezz lenders or a total denial of additional borrowing.
Overall, mezz debt provides a creative opportunity for sponsors to secure additional financing and a higher LTV. For lenders, mezz lending allows them to get equity-like returns with debt-like protections. In the following sections, we’ll break down the benefits, drawbacks, and current market opportunities in four key sectors. Each sector has a current use and need for mezz debt providing an opportunity for both lenders and borrowers.
Real Estate
Benefits: Mezz financing in real estate enables developers and property owners to secure higher overall LTVs. By using mezz debt, sponsors can decrease their equity contribution. As a result, this saved equity can be put towards additional deals, renovations, or developments. This can enable investors to enhance returns when property values appreciate because they maintain greater ownership using borrowed capital. Real estate loans are almost always non-recourse, meaning that in case of default, the senior lender gets the real estate asset and only the real estate asset as payment. Senior lenders aren’t in the business of running assets, so default can usually result in a fire sale of an asset at a significant discount. Many real estate mezz lenders (think real estate private equity firms backed credit arms) are often also in the business of private equity and asset management. Because of this, and the fact that mezz lenders are in between the senior lender and equity investors, they often act as a reserve operator in case of default. This gives the mezz lender an opportunity to take over a distressed property at a discount. This scenario, considering the mezz lender is a seasoned operator, is also beneficial to the senior lender. It’s important to note that this can also be a drawback, especially if a mezz lender doesn’t have the resources or experience to properly act as back-up operator.
Drawbacks: Mezz debt is expensive, with interest rates typically ranging from 10-15%, significantly more expensive than senior loans. This increased debt service can strain a building’s cash flow, resulting in more risk, especially when weaker market conditions arise. Mezz lenders are also taking on risk by being subordinate lenders. If property values decline or an asset fails, mezz lenders may lose all of their investment. Senior lenders can also complicate deals for mezz lenders by imposing restrictions in the original loan terms. Mezz debt can also attract risky lenders, creating a snowball effect of risk and potential losses.
Opportunity: Bank lending standards are tightening, resulting in an inability for real estate borrowers to secure significant senior financing. LTV ratios are lower right now, generally closer to 60%, leaving a large financing gap. This results in a great opportunity for mezz lenders, as property owners facing refinancing difficulties are willing to pay a premium for additional capital. As commercial real estate markets remain in flux and interest rates remain high and uncertain, mezz lenders can act now, receive favorable terms, and even get stronger protections compared to previous market cycles, as borrowers are willing to do it. Equity is scarce and senior debt is both relatively expensive and not sufficient. One example is a $57.5 million loan from CIM Group’s Real Estate Debt Solutions to refinance a four-building industrial property portfolio.
LBOs & Private Equity
Benefits: In LBOs, mezz debt can be a valuable tool for private equity firms to enhance returns by minimizing equity investment. Mezz debt can also offer higher flexibility of repayment, such as deferred interest payments or payment-in-kind (PIK), which allows interest to be capitalized (added to the principal) and paid later, typically when the firm sells the company or refinances the debt. This helps preserve cash flow, which can be necessary when acquiring a company that may not generate immediate excess cash to service high-interest mezz debt payments on top of senior debt payments.
Drawbacks: The high cost of mezz debt makes it more expensive than traditional senior debt. To compensate for higher risk, mezz lenders may require an equity kicker (most commonly warrants or profit participation), which is an additional financial incentive giving the lender upside if the company performs well. Warrants allow the lender the right to purchase equity shares in the future at a set price, typically based on today’s value. Profit participation allows a mezz lender to negotiate a percentage of future profits upon a sale or IPO of the company. These kickers are dilutive to the sponsor’s ownership stake, but provide mezz lenders a great opportunity for additional profit if a company succeeds. Subordination risk makes mezz lending more risky, because these lenders aren’t the number one priority to get paid back. Excessive use of mezz debt can also lead to overleveraged deals, increasing the risk of financial distress.
Opportunity: Similarly to real estate, the fact that banks are scaling back on higher leveraged loans means many private equity firms are turning to private credit and mezz lenders. This has created a strong market for mezz investors, as we see demand for alternative financing remain high. The spread between senior loan rates and mezz rates has decreased, resulting in relatively cheap mezz debt options for sponsors. As private credit becomes a more popular option, competition among mezz lenders is leading to more flexible deal structures, benefiting borrowers. One example is Olympus Partners’ acquisition of AmSec Holding Corp using mezz debt.
Corporate Expansion & Growth
Benefits: Compared to issuing new equity, which reduces ownership stakes, mezz financing is a non-dilutive way for growing companies to raise capital. This can be beneficial for businesses looking to expand without bringing in external and additional equity investors. Mezz financing is also beneficial for these growing businesses that tend to have limited tangible assets. This is beneficial because, as discussed earlier, mezz lenders typically rely on cash flow as collateral as opposed to hard assets.
Drawbacks: The largest downside is the high cost of borrowing. These high rates can put pressure on cash flow if growth isn’t meeting expectations. Increased leverage can be especially risky for less distinguished companies, as taking on too much mezz debt can result in a higher likelihood of default, particularly if market conditions weaken. Additionally, if a company can’t repay the mezz loan at maturity, they may be forced to refinance at an even higher cost or issue equity in the form of equity kickbacks.
Opportunity: The most general opportunity is again, an increase in demand for capital. Like every other example, mezz lenders are filling this gap. On top of banks scaling back on lending in general, senior loans typically require tangible collateral. On the other hand, mezz lending structures collateral around cash flows, providing a beneficial opportunity for both growing companies with fewer tangible assets to access more capital, and strong demand for mezz lenders to lend to these companies. One example is Liquidity Capital’s $450 million investment in expansion, including significant mezz debt.
Infrastructure & Energy
Benefits: Infrastructure and energy projects require significant upfront capital investment. Mezz debt can play an important role in reducing the equity burden of this investment. By adding mezz financing, developers or investors can better fund these massive projects with less equity dilution. Further, mezz debt aligns well with long-term project cash flows. Senior development loans, often with higher rates than traditional loans, are usually interest only during the development period and repaid after stabilization, during a refinance transition to a traditional loan. Mezz debt doesn’t need to be paid off at stabilization and often includes PIK interest until stabilization. This creates flexible options during both the development process and into the hold-period of the asset.
Drawbacks: High leverage is also a major risk for the development and investment of infrastructure and energy projects. If a project faces cost overruns, delays, or revenue falls short of expectations, mezz lenders face significant risk. Infrastructure financing is also very complex, often including multiple layers of debt and equity as well as major regulatory inspection. Refinancing during distress can be a challenge considering this complex structure. Lastly, because these projects are often so massive, they require a significant amount of capital that lower-scale mezz lenders typically won’t be able to provide.
Opportunity: Investment in infrastructure, data center demand, and clean energy transition projects are all at an all-time high. According to a 2025 Goldman Sachs report, global demand for power, largely driven by AI, will result in a 165% increase in data center power demand by 2030. According to a S&P Global 2024 report, the U.S.’s data center power consumption is expected to grow at an annual rate of 12% through 2030. And according to a 2025 Reuters report, to align with global net-zero targets by 2050, annual global investments in energy transition must average about $5.6 trillion between 2026 and 2030. Considering this and the trend of traditional banks scaling back, these projects will likely require structured financing solutions that combine senior loans, mezz debt, and equity. Major government incentives (ex. Investment Tax Credit, Production Tax Credit) for renewable energy and large-scale infrastructure, often reduce the cost of development but don’t provide upfront capital, creating a strong demand for mezz financing to fill the gap without diluting the equity of these massive projects. One recent example of this is in 2021, during development, Mainstream Renewable Power secured a $280 mezzanine finance facility from AMP capital with very unique and flexible terms. The Stargate Project is another major example ($500 billion data center initiative financed with 90% debt including mezz and preferred equity).
Final Thoughts
Tighter bank lending, persistently high interest rates, and a surge in demand from private equity, real estate, infrastructure, and energy sectors have collectively driven mezzanine debt from a niche and cyclical product into a more permanent fixture in modern capital structures. What was once used opportunistically during specific market windows is now seen as a flexible, non-dilutive tool for sponsors and companies navigating capital-intensive growth, acquisitions, and refinancing needs.
However, the increased recognition invites scrutiny. As capital floods into private credit markets (tripling globally since 2007) the risk isn’t just in overuse, but in complacency. The real danger lies not in mezzanine debt itself, but in how it’s underwritten. In Howard Marks’ words, “it [the race to the bottom] is on today, but I don’t think it’s terrible today, it’s just the markets are a little bit generous.” And while today’s generosity might not mirror the recklessness of the 2008 financial crisis, the warning signs are familiar: looser covenants, aggressive leverage, and the false safety of unmarked valuations.
Unlike public credit, private credit doesn’t require mark-to-market adjustments. That’s part of its appeal to investors, stability in pricing even during turbulence. In a downturn, inaccurate write-downs in private credit, particularly in mezzanine structures, could mask deeper systemic risks. This risk is amplified in pooled mezzanine debt vehicles, private funds that aggregate mezz loans across sectors. While they offer diversification, they also dilute transparency. Investors often don’t fully grasp the credit quality or concentration risk they’re exposed to. If underwriting standards continue to slip, a single underperforming loan cycle could echo across portfolios, affecting returns far more than expected.
So, what’s next for mezzanine and alternatives? With the public markets still volatile – and traditional lenders cautious – mezzanine debt will remain attractive, but survival will depend on discipline. The winners in this next chapter won’t be those who chase every deal, but those who can say “no” more often than “yes.” It could be that we see greater differentiation among lenders, more rigorous deal scrutiny, and different divisions of mezz lending (institutional-quality mezzanine debt vs. speculative mezz in murkier parts of the market).
Beyond mezz, the future could likely hold greater investor interest in structured equity, hybrid debt instruments, and asset-backed private credit. In the end, it comes down to judgment, luck, and sometimes just being first, because in every cycle, and as Warren Buffet often says, “what the wise man does in the beginning, the fool does in the end.”