As a property developer, you may be looking for additional funding for your project on top of your development finance. Mezzanine finance bridges the gap between the funds you have provided and the development loan. It can help lower the amount of deposit you need to raise, protect your cash flow, see a greater return on your capital and enable you to take on additional development projects.
How does it work?
Mezzanine finance can be used to help fund some of the costs for your development project, over and above the funds you’ve already secured via development finance. The mezzanine lender releases the funds to you as work progresses on your project and as you need them. Lenders for mezzanine finance usually take a second charge over the development behind your development finance, which is the senior debt.
Typically, the breakdown of the funding between the main lender, the mezzanine lender and you is split 70:20:10. Some mezzanine lenders offer a higher percentage, though, depending on your project.
In return for the mezzanine finance, you repay the funds to the lender along with interest and a percentage of the profit. This makes mezzanine finance a hybrid funding option between standard equity and debt financing.
The lending criteria
You can arrange mezzanine finance for residential and commercial development projects, including extensive refurbishments and new-builds. The following lending criteria usually applies:
- Lenders prefer experienced developers with proven credentials
- You must have full planning permission
- You have to supply a personal guarantee
The advantages of using mezzanine finance
Mezzanine finance can have lots of advantages even if you already have the cash available for your project:
- It can provide you with additional funding to your senior debt.
- It can cost less than raising equity.
- It can reduce the amount of deposit you need to get started with your project.
- By taking on a loan instead of using your cash, you can protect your cash flow.
- Mezzanine finance reduces the amount of capital you need to invest. This, in turn, provides a higher return on your personal investment. It also frees up your money to invest in other projects.
- The application process tends to be streamlined so that you can benefit from quick access to the funds.
- Mezzanine lenders usually offer flexible repayment options.
- The lenders don’t usually get involved with the management of your development project, giving you more control than if you brought equity partners on board.
- Interest payments on mezzanine finance can sometimes be tax deductible.
The interest rates
As the mezzanine finance ranks behind your senior debt in priority, it is considered more of a risk to the lender, meaning the interest rate is higher. The rates differ between lenders and each application is assessed on a case-by-case basis. These factors are taken into consideration:
- The amount of deposit you can invest
- Your experience as a developer
- The development’s location
- The amount of funding you require
- The anticipated demand for the completed development
Share of the profits
The higher the percentage of mezzanine finance provided for your project, the larger the share of your profits the lender will require. For example, the main lender has agreed to 70% of the funding for your development project in Bexley. You can invest 10% and require 20% from the mezzanine lender. The profit from the project will be split between you and the mezzanine lender, with the lender receiving 35% and you receiving 65%.
As a comparison, another example is a development project you need funding for in Bexleyheath. Again, the main lender has agreed to 70%. You are able to invest a higher amount of 15% and, therefore, need a lower amount of 15% from the mezzanine lender. From the project’s profit, you receive a higher share of 70% and the mezzanine lender receives a lower share of 30%.
What alternatives are available?
If you have little or no capital to invest, joint venture development finance provides you with 100% of the project’s costs. Once the project is completed, the lender takes a share of the profit. Although you have to share the profit, this option lets you move forward quickly with your development without tying up any capital in the meantime.
Before making a decision about your funding, get expert advice from your specialist broker in Kent, London or Edinburgh. Every case is different and your broker can assess your situation and ascertain which type of funding is best for your needs. Your broker will know which lenders to approach and the best way to present your case. By utilising the help of your broker, you can be sure to receive the best finance deal to fund your development project in a timely manner.