This article will review both the genesis and the rise in popularity of preferred equity and mezzanine debt, examine their legal and structural differences, and provide some exposition as to how these financing techniques work from security, collateral and control standpoints. We do not undertake in this article to address the differences in tax and accounting treatment between mezzanine loans and preferred equity investments both for either the mezzanine lender or preferred equity investor on the one hand, or for the mezzanine borrower or the common equity investor, on the other hand. In deciding upon which structure to use, transaction participants should consult with their independent tax and accounting advisors to ensure that the transaction is appropriately structured to best meet their individual needs, subject to such compromise as may be necessary to effect a desired transaction. We proceed as follows: Section II outlines the legal principles of, and the practical realities that have shaped, real estate finance from common law to modernity. Section III begins with an exposition of the preferred equity instruments and mezzanine debt that form the subject of this study. It will start by outlining their qualities and follow with a delineation of the organizational structures used in deals in which they form part of the capital structure. Lastly, it will proceed through theoretical and practical issues for legal counsel to consider. Section IV will address an open issue, never, to the authors’ knowledge, having been before a court: whether these funding mechanisms should be treated as equitable mortgages according to the common law equitable tradition to treat mortgage-like agreements as mortgages. This Section will argue that these funding mechanisms should not be treated as equitable mortgages. Finally, we will set forth our conclusion in Section V.
Jon S. Robins, David E. Wallace & Mark Franke, Mezzanine Finance and Preferred Equity Investment in Commercial Real Estate: Security, Collateral & Control, 1 MICH. J. PRIVATE EQUITY & VENTURE CAPITAL L. 93 (2012).