Proposed NYS Legislation May Increase the Cost of Mezzanine Financing
A bill introduced in January in the New York State Legislature seeks to extend the mortgage recording tax to mezzanine debt financing. The proposed Senate Bill S7231, if enacted, has the potential to significantly impact real estate lenders, owners and developers of properties in New York State who utilize mezzanine debt as a financing vehicle.
There are a number of details to be clarified with respect to the bill as it is being discussed in committee. While mezzanine debt is commonly understood as securing the ownership interests in a property owning entity, the pending bill defines mezzanine debt as “debt carried by a borrower that may be subordinate to the primary lien and/or common shares and reported as assets for the purposes of financing such primary lien”. Accordingly, the bill’s broad definition is vague as to whether the proposed tax could be imposed on more than just a traditional mezzanine loan. The bill is also vague as to the nature of the instrument that would need to be recorded to trigger the tax (as a UCC is the only instrument currently recorded for mezzanine debt), as well as the timing of recording of such instrument in relation to a primary mortgage on the property.
The increase in the cost of mezzanine financing can be substantial. The current mortgage recording tax rate, which would be applied to mezzanine debt under the bill, is 2.80% in New York City for commercial mortgages of $500,000 or more (outside of New York City, the mortgage recording tax is 1.00% in most counties).
In the event the bill is passed into law, certainly alternative financing structures, such as preferred equity structures, will be utilized. However, given the lack of clarity under the proposed bill, financing structures which may be logical substitutions (such as so called “disguised debt” preferred equity) may also be at risk of being subjected to the tax. In the end, borrowers seeking alternatives to mezzanine debt could be faced with choosing between accepting loans subject to the mortgage tax or raising more equity (through preferred equity transactions that would not be subject to the tax or otherwise), both at higher costs.
As the proposed bill proceeds through the legislative process, we anticipate that the details will be clarified, and we will provide updates on the status of this pending bill as they become available.
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