Gap funding covers the space between your senior loan and the total project cost so you can close deals without draining cash reserves. Kestrel Lending puts 20+ Texas lenders in competition on your deal, helping you find gap funding, mezzanine loans, and preferred equity from several sources. One application. Multiple offers. Honest cost guidance before you commit. Get Your Rate in 24 Hours.
Gap funding is subordinated debt or equity capital that covers the difference between senior debt and the entire project cost on a real estate investment. Senior lenders typically fund 65% to 80% of a purchase or development project. The remaining portion is the gap. Many investors fund that gap with personal savings. Gap financing provides an alternative: a second lien, mezzanine debt on your entity, or preferred equity from a capital partner. In either case, the gap capital means you fund the project with less personal money out of pocket. The goal is to close the deal, maintain working capital, and fund more acquisitions across the market. In addition, borrowers who fund deals with gap capital can preserve the ability to fund future opportunities without selling other assets.
Real estate investors use gap funding when deal margins support the additional costs. Gap funding is common in commercial real estate, fix and flip deals, and ground-up construction. This type of financing is not cheap. Mezzanine loans and gap funding carry higher interest rates, shorter timelines, and increased risk. Used on the right deals, gap funding helps investors fund multiple projects, close more transactions, and scale operations without waiting years longer to save enough equity to fund each purchase. Many investors over the years have used mezzanine loans to fund acquisitions that would otherwise require too much cash on hand.
The structure you choose determines who holds the collateral, how lenders get paid, and what happens if the borrower defaults. Here are the four structures mezzanine lenders and gap funding providers use to cover the gap in real estate deals. Each form of gap capital has different risk, cost, and priority characteristics.
A second-position gap loan is directly secured by the underlying property, subordinate to the senior debt. If borrowers default, the senior lender is repaid first. The gap funding provider receives what remains. This is the simplest gap funding structure and offers limited complexity for borrowers who meet the requirements. Mezzanine lenders who provide second-position loans typically charge 12% to 18% interest because of the subordinate position. Senior lender consent is required because the primary loan documents usually restrict further financing on the collateral.
Mezzanine debt is a loan to the borrower's entity (the LLC or LP), not a lien on the real estate. Real estate mezzanine loans are technically unsecured against the property (unsecured in the traditional sense, meaning no direct property lien) but secured by the borrower's ownership interest in the entity. If the mezzanine borrower defaults on mezzanine debt, the mezzanine lender can foreclose on the entity rather than the property. This structure lets mezzanine debt sit alongside senior debt without complex rules around priority of claims.
Mezzanine loans typically carry higher interest rates than senior debt (14% to 20%+). Some real estate mezzanine loans also include an equity kicker. This hybrid structure means the mezzanine lender receives a percentage of profits in addition to interest payments. This hybrid form of financing makes the cost harder to predict upfront. Real estate mezzanine loans are considered standard in larger commercial real estate acquisitions and development projects where the capital stack draws from several sources.
Preferred equity is not debt. It is an equity investment in the entity that owns the property. Preferred equity investors contribute capital and in return receive priority on distributions, typically earning preferred returns of 12% to 18% before common equity holders are paid. Preferred equity ranks below senior debt and mezzanine debt on the balance sheet but above common equity.
The benefit for borrowers: preferred equity does not appear as debt, it may avoid triggering senior lender consent requirements, and it can provide flexibility that mezzanine loans do not offer. The cons: you give up a portion of control, profits, and upside returns. Preferred equity financing is common in commercial real estate joint ventures and situations where the sponsor needs capital but cannot take on more subordinated debt.
Cross-collateralization uses equity in one property to fund the gap on a different deal. If you own a stabilized asset with $150,000 in equity, a lender may lend against that asset to fund your new acquisition. This structure avoids mezzanine debt or preferred equity but puts two assets at risk. It works for experienced borrowers making multiple acquisitions who want to maintain control without bringing in outside capital partners.
| Term | Typical Range |
|---|---|
| Interest Rates | 12% to 20%+ (higher interest rates reflect increased risk in subordinate position) |
| Profit Share | 10% to 50% of deal profits, depending on structure |
| Gap Coverage | 10% to 25% of total project cost |
| Combined LTC (Senior + Gap) | 85% to 95%, investor brings 5% to 15% |
| Loan Term | 6 to 24 months |
| Monthly Payments | Interest only, sometimes accrued and paid at exit |
| Points | 2 to 5 on gap funding amount |
| Closing Costs | Legal fees, intercreditor agreement, title endorsement |
| Collateral | Second-position security, entity ownership pledge, or preferred equity position |
| Senior Lender Consent | Required for second-position loans; sometimes waived for mezzanine debt |
| Personal Guaranty | Full or partial recourse on most deals |
Terms vary depending on the lender, deal size, and borrower experience. Lenders may offer different terms depending on the value of the property and the transaction structure. Having several sources compete on your deal is the best way to determine the right combination of cost, structure, and conditions. Every transaction is evaluated on the deal and the property, not just borrower characteristics. Understanding the pros and cons of each structure is important before making a decision. Investors should review each term sheet and provide their team with complete deal information so the terms can cover all project requirements.
Here is an example of how gap funding works on a Texas fix and flip. In this case, the investor uses senior debt plus gap funding to fund the deal with less cash. This example shows why many investors fund projects with layered capital.
Without gap funding, the investor brings $120,000 in cash. With it, the investor brings $60,000 plus closing costs. That saving matters when borrowers fund multiple projects or need to preserve cash reserves for longer timelines.
Gap funding added $6,600 in cost but freed $60,000 in capital. If you fund a second deal with that capital and earn similar returns, the net result exceeds the cost by a wide margin. That is the math that makes gap funding a useful option for active real estate investors who fund deals across the market. Run your own numbers on our loan calculator.
Mezzanine loans and gap funding are expensive money. Use them only when the deal supports the cost and you have a clear exit strategy. These are the situations where gap financing provides the most benefit:
Gap funding is the most expensive layer in any capital stack. Mezzanine lenders charge higher interest rates because they sit behind senior debt and absorb more risk. In each case, the higher cost means higher total payments on the project. If the deal fails, the senior lender is paid first. The gap lender may receive nothing.
Many mezzanine loans also require a profit share, which means the lender receives a percentage of your returns. On a deal with a 15% profit share, that cost can exceed the interest payments and points. Preferred equity investors typically require preferred returns paid before common equity holders see any distributions.
The important question is not "is gap funding expensive?" It is "does this deal produce enough returns to cover both layers of cost and still meet my investment goals?" If the answer is yes, mezzanine financing is a tool that helps you fund deals you would otherwise miss. If the returns are thin (less than 20% gross profit), adding mezzanine debt or gap funding can turn a profitable deal into a loss. Evaluate each opportunity on its own numbers. Caution is important when making decisions about additional leverage. The pros of gap funding include the ability to increase your deal volume and the potential to fund more acquisitions. The cons include higher payments, more complex terms, and the potential for longer closing timelines.
The gap funding space attracts scams. Legitimate mezzanine lenders do not require large upfront fees before closing. Watch for these red flags:
We vet every mezzanine lender and gap funding source on our panel. Our clients and borrowers deal with established capital providers who lend on real estate, not unknown operators making promises on a website page with no content or service behind them. You can email our team or contact us on our site for assistance. We assist you in navigating the closing process and help cover any gaps in documentation or requirements.
Gap funding carries real risk. Understand these factors before you take on mezzanine debt or preferred equity:
Mezzanine financing is a tool for experienced investors who understand leverage and deal structure. If this is your first investment, start with a standard fix and flip loan or bridge loan. For more on hard money loan down payments, read our guide. Also learn about DSCR loans in Texas as a long term option. Lenders may require higher cash reserves for borrowers with limited experience. Lenders may also offer flexibility on terms for investors who can provide a strong track record and business plan.
Kestrel Lending is a Texas hard money broker. We put 20+ lenders in competition to fund your deal, including mezzanine lenders and preferred equity providers who offer gap financing for real estate investors.
We broker business-purpose loans on investment property only. We source gap funding and mezzanine loans for deals in Houston, Dallas, San Antonio, Fort Worth, Austin, and statewide Texas markets. See how the full process works.
Gap funding is a general term for any capital that fills the gap between senior debt and total project cost. Mezzanine debt is a specific type of subordinated debt where the loan is secured by entity ownership, not by a claim on the property. Second-position loans, mezzanine debt, and preferred equity are all considered forms of gap funding used in real estate investment.
Some deals reach 90% to 95% of cost when borrowers combine senior debt and gap funding. True 100% financing is rare and requires strong deal economics, experience, or cross-collateralization of other assets. Expect to bring 5% to 15% in cash. Read about 100 percent financing options.
Mezzanine loans typically cost 14% to 20% in interest plus 2 to 5 points. Some mezzanine lenders also require a profit share of 10% to 50%. Preferred equity may cost less in interest but more in profit sharing. Evaluate the combination of fees, interest payments, and profit share against the deal returns before you fund.
For second-position gap loans, yes. For mezzanine debt secured by entity ownership or preferred equity, consent may not be required. Review the senior loan documents. Some senior lenders include broad restrictions that cover all forms of equity financing and subordinated debt.
The result depends on the structure. A second lien holder can foreclose after the senior lender is paid. A mezzanine lender can take control of the entity. A preferred equity investor may convert to common equity or force a sale. Senior debt is always repaid first. The gap lender absorbs the loss if proceeds fall short.
Generally, no. Gap funding adds higher interest rates, increased risk, and complexity. First-time investors benefit from simpler structures. Build experience on a few deals, learn how mezzanine lenders evaluate opportunities, and understand how the capital stack works before adding a second layer of financing. Gain hands-on experience in real estate investment first.
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