Subordination
The contractual arrangement establishing the priority of claims between different creditors or capital providers in a real estate transaction. A subordinate lender agrees that their claim on the property's cash flows and collateral ranks below the senior lender's claim. Subordination is a fundamental concept in structuring the capital stack and directly impacts the risk and return profile of each position. The terms of subordination are documented in intercreditor or subordination agreements.
Related Terms
Capital Stack
The layered structure of capital used to finance a real estate investment, arranged by priority of repayment. From lowest risk to highest: senior debt, mezzanine debt, preferred equity, and common equity. Each layer has different risk/return profiles. Understanding the capital stack is essential for structuring deals and evaluating investment opportunities.
Senior Debt
The primary mortgage loan that has first priority claim on a property's cash flows and collateral. Senior debt sits at the top of the capital stack with the lowest risk and lowest cost of capital. Senior lenders are repaid before any subordinate financing or equity in case of default or sale.
Mezzanine Debt
Subordinate financing that sits between senior debt and equity in the capital stack, secured by a pledge of ownership interests rather than a mortgage on the property. Mezzanine debt allows borrowers to achieve higher leverage (up to 85-90% of cost) while keeping the senior loan in compliance. Rates are higher than senior debt but lower than equity returns.
Intercreditor Agreement
A legal agreement between two or more lenders that defines their respective rights, priorities, and remedies with respect to the same borrower or property. Intercreditor agreements are required when a capital stack includes both senior debt and subordinate financing such as mezzanine debt or a B-Note. Key provisions include standstill periods (restricting the junior lender from exercising remedies), cure rights (allowing the junior lender to cure senior defaults), and purchase options (allowing the junior lender to buy the senior position).
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