How to use Mezzanine Finance for Property Development

24-August-2017
24-August-2017 9:36
in General
by Admin

One of the main challenges that property developers face is securing the right funding for their project.  Traditionally, it was commonplace for developers to use a combination of their own personal capital and a loan from a high street lender.

Property development is becoming increasingly competitive and attractive opportunities are taken quickly, which has forced developers to become more innovative in securing finance fast.

In addition, some property developers may find that traditional lenders may not provide enough finance to complete the project. 

As a result, in today's rapidly changing economic landscape, it is becoming more common to have structured financings consisting of various components. Developers are constantly looking for additional ways to fund their projects.

Whether you need property development finance quickly or there is a shortfall in funding provided by a traditional lender, mezzanine finance may be a viable option.

What is Mezzanine Finance?

If a developer already has existing finance in place, but there is a shortfall in the funding, a mezzanine loan may be able to provide further finance to ‘plug’ the gap. This could ensure that the developer progresses the project to completion without any costly delays.

Mezzanine finance sits behind the prime lender and acts as a second charge for the development. The majority of mezzanine loan lenders are prepared to provide up to 20% of the gross development value.

It is commonplace for the breakdown of funding to be:

  • Prime lender: 70% of the total cost
  • Mezzanine lender: 20% of the total cost
  • Developer: 10% of the total cost

Not only could mezzanine finance supply the additional finance required to complete a project, but it could enable property developers to minimise the amount of personal capital tied up in a project.  The ability to reduce the amount of capital invested in a single project may allow developers to invest in multiple development projects at the same time.

The Features of a Mezzanine Loan

If a developer needs a more flexible sort of finance, a mezzanine loan might be suitable because it allows the developer more freedom than other loans.

A mezzanine loan may provide a substantial amount of funding with terms of finance that can be tailored to the requirements of the developer.

Mezzanine loans are a popular source of finance because they:

  • Enable developers to acquire the additional funding they need
  • Can be secured within 28 days
  • Provide up to 20% of the gross development value
  • Have repayment plans between 12 and 24 months

In addition, mezzanine loan lenders often provide the option to ‘roll up’ their interest to be paid at the end of the term of finance. This may offer peace of mind to a developer who wants to avoid monthly interest payments.

Example: A developer wants to purchase a £1 million property but can only secure £700K from their bank . They do not wish to put £300K of their personal capital into the property, so they approach a mezzanine lender to provide a portion of the remaining price. The mezzanine lender agrees to provide £200k, allowing the developer to only invest £100k.

When can Mezzanine Finance be used?

Mezzanine funding is used regularly by property developers for a variety of different and can be used:

  • Anywhere in the United Kingdom
  • To contribute to land purchase costs
  • As development costs for residential new builds or refurbishments
  • For the purchase or development of commercial property

Generally, a property developer will need mezzanine finance on the first day of the development to contribute to the purchase price. Therefore, it is advisable to contact a specialist property finance broker to secure the best mezzanine loan to suit the requirements of the project. 

Mezzanine loan lenders will only agree to provide funding if they can see a high chance of return. This is because they want to minimise the amount of risk that they take on.

As a trade-off for this fast flexible financial service, mezzanine loans will typically come with one or both of the following:

  • Higher interest rates
  • A percentage of profits

Mezzanine development finance can include high interest rates or an agreement for profit sharing, but it is a valuable tool to free up developers’ capital.  Developers appreciate this, as the more capital available the more they can take advantage of investment opportunities. This ultimately creates more avenues for additional income.

Who Can Secure Mezzanine Finance?

It is important to note that not all developers can access mezzanine finance.  To reflect the higher risk that mezzanine lenders take on, they restrict their lending to experienced property developers with a strong portfolio of successful projects. This is to maximise the likelihood that the developer will repay the entire loan.

Therefore, mezzanine loan lenders seldom provide finance to new or inexperienced property developers. This is because there is too much risk associated with providing property development finance to someone without experience or a portfolio of successful projects, as the probability of repayment is low.

In the rare circumstances where mezzanine finance providers agree to lend to an inexperienced developer, the loan will almost definitely come with a lot higher interest than a normal mezzanine loan.

How to Get a Mezzanine Loan?

There are many mezzanine financial products available, however it may be difficult to decide which loan is suitable for your needs. The best course of action, to get a true picture of the mezzanine finance landscape, may be to enlist the help of a professional broker. In the event that mezzanine finance is required, it is advisable to contact a specialist property finance broker to ensure that the mezzanine loan is appropriate, with fair terms and at the best available rates.

 

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