The New York State Assembly is working on legislation that could introduce a recording tax for mezzanine debt and preferred equity investments completed in the state.
The legislation aims to impose the same recording tax for mezzanine debt and preferred equity as already exists for mortgages in the state and could come into effect later this year – at a time when sponsors are already expected to be strapped when looking at refinancing existing loans, said Ilya Leyvi, a partner and real estate finance practice co-chair at New York-based law firm Adler & Stachenfeld. The tax could be up to 2.8 percent for New York City.
“If this mortgage recording tax goes into effect in New York, where mezzanine debt and preferred equity are a tried-and-true part of a commercial real estate capital stack, it would potentially add another 2.8 percent of expense to a deal,” Leyvi said. “This would be a significant change.”
The legislation would add a significant expense to transactions at a time when many sponsors are already cash-strapped, Leyvi noted.
A sponsor with a property valued at $100 million who wants to put into place a capital stack comprised of a $50 million mortgage and a $10 million mezzanine loan would have to pay a $1.4 million recording tax on the senior mortgage and another $280,000 in recording taxes for the mezzanine loan. That said, the recording tax for the mezzanine loan could be offset to the extent of existing debt by an assignment process, although it is unclear if such assignment process to save on recording taxes will be accepted for a new mezzanine recording tax, he added.
“A 2.8 percent tax on mezzanine loans and preferred equity would be coming at a time when sponsors are struggling or having a difficult time finding the best way to refinance debt that they took on when interest rates were low. Now that all interest rates are rising and the cost of rate caps has really skyrocketed, having an additional tax will be very difficult for borrowers who are already on the brink. It will have a very negative effect on their ability to refinance,” said Bruce Stachenfeld, chairman of Adler & Stachenfeld.
In addition to the functional impact higher costs would have on the market right now, there is a lack of precision in the wording of the proposed legislation and a blurring of the lines between mezzanine debt and preferred equity, Leyvi said.
“Mezzanine debt, often used in conjunction with senior mortgage debt to fill out the capital stack, is secured by a pledge of the equity in the underlying property. Preferred equity is a form of equity which sits above common equity and has some additional rights, but is rarely secured,” Leyvi added.
Other concerns include a lack of clarity over how high in the capital stack the use of preferred equity or mezzanine debt would be tracked and if public real estate investment trust or other parties which indirectly own real estate would be affected.
In addition to the costs associated with recording, the proposed legislation could make it more onerous for mezzanine lenders to enforce remedies – including foreclosures – under the Uniform Commercial Code unless the necessary financing statements have been filed and applicable taxes have been paid. Mezzanine lenders have the right to foreclose in situations in which a senior mortgage is in default, Leyvi said.
There is a parallel bill that has been proposed in the state Senate. Bill 7231, however, would only require recording requirements and taxes for mezzanine debt and stipulates that any taxes collected would be specifically allocated toward the funding of affordable housing in New York. Another factor in play will be the need for the Assembly and the Senate to reconcile their competing bills.
This is the third time the state has tried to impose this tax, with attempts in 2020 and 2021. This time, however, there is a strong sense the legislation may pass because of the long-term impact of the covid-19 pandemic, rising interest rates, and a widely anticipated recession.
“If the state is looking for more tax revenue, adding more income tax on high-income earners is not the optimal strategy,” Stachenfeld said. “A tax that 99 percent of the state hasn’t heard of and doesn’t understand is more likely to pass. But what we are concerned about is that this will drive up the cost of capital for this type of transaction and it just encourages capital to be put to work in other states.”