Mezzanine debt vs. preferred equity: how sponsors should choose
Both sit below senior debt in the capital stack. The difference is what happens when a deal underperforms.
Same place in the stack, different legal position
Mezzanine debt and preferred equity both occupy the gap between senior debt and common equity, and both get priced and underwritten similarly on the surface — comparable return expectations, both subordinate to the senior loan. The meaningful difference is legal: mezzanine debt is debt, typically secured by a pledge of equity interests in the property-owning entity, with contractual remedies — including the ability to foreclose on that equity pledge — if the borrower defaults. Preferred equity is equity, with negotiated rights (control triggers, forced-sale rights) rather than a security interest, and its remedies for underperformance run through the operating agreement rather than a loan document.
Why that difference matters when a deal goes sideways
In a stabilized, performing deal, the practical difference between the two is often minor. It stops being minor the moment a deal underperforms. A mezzanine lender's remedies are generally faster and more certain — a pledge of equity interests can typically be foreclosed on more directly than preferred equity rights can be enforced, which often require negotiation or litigation to actually take control. Sponsors evaluating capital partners should weigh this: preferred equity often gives the sponsor more practical runway and negotiating leverage if a deal underperforms, which is part of why it's frequently priced at a premium to mezzanine debt for comparable risk.
Senior lender consent is a real constraint on both
Most senior loan documents restrict subordinate financing, and getting senior lender consent for either mezzanine debt or preferred equity — including standard intercreditor or recognition agreement terms — is frequently the actual bottleneck in structuring the deal, not the terms of the subordinate capital itself. This is an area where the relationship with the senior lender matters as much as the mezzanine or preferred equity terms.
How we help sponsors choose
The right answer is rarely "mezzanine is always cheaper" or "preferred equity is always more flexible" — it depends on the sponsor's risk tolerance for a downside scenario, the senior lender's consent requirements, and how much control the sponsor is willing to negotiate away. We structure both regularly and help sponsors run the actual comparison against their specific deal and their specific senior lender, not a generic rule of thumb.