Market for mezzanine debt is taking off.

A new kind of debt deal is heating up among Wall Street lenders and opportunity funds these days, driven in large part by rising prices and falling cap rates for almost every category of real estate in the nation.

Mezzanine debt, as it's called, is high-yield, high-risk financing for commercial properties that need more debt than the maximum loan-to-value ratio allowed by lenders, according to Pergolis Swartz Associates, one of the most active commercial mortgage brokerage firms in the New York area.

With rates set three or four percentage points above market mortgage rates, the most aggressive lenders in the industry are actively pursuing them. And with real estate prices rising for many types of property in many locations, owners are much more willing to take on debt, even high-priced debt, than to take in equity partners who would capture a share of the market appreciation.

"It's fairly simple economics," said Jerry Swartz, a principal in Pergolis Swartz Associates. "If I need to invest capital to keep my building competitive, I can either use equity capital or debt capital. With values rising, many owners are betting that even expensive leverage is cheaper in the long run than giving away equity to an outside investor."

Swartz notes that there are essentially two scenarios that are now driving the mezzanine debt business. The first is owners who aced additional leverage to improve the property and thus make it worth more, but the bottom line won't support enough debt. Many of these deals are retail centers and residential properties in markets where rents are rising and tenants are relatively plentiful. The second is owners who have property that was over-leveraged in the '80's and are facing maturing loans.

"If my property hasn't appreciated since the last time it was financed, current loan-to-value ratios are going to prevent any lender from lending me the full amount of the last mortgage," said Richard Pergolis, also a principal in Pergolis Swartz Associates. "I've either got to come up with more equity capital - my own or from another party - or look at covering the shortfall with mezzanine debt. Many borrowers are finding the mezzanine option very attractive."

In the scale of risk and return, mezzanine debt falls halfway between traditional debt and equity. It is generally secured, and pre-payable without yield maintenance. It is almost always self-liquidating, often on a five-year schedule, so principal and interest payments are level. Yields are substantially higher than first mortgage debt.

"It may be one of the few pure rate plays we're seeing the most aggressive lender go for," summed up Swartz. "Almost everything else in the debt world is bound for securitized pools. These loans are typically held in portfolio and are often being done by players who usually prefer equity. I think it's a sign of the optimism in the market, both among owners and lenders, that these deals are being consummated."