• James Wyllie

What is mezzanine finance and is it right for you?

Updated: Jul 15, 2021

Overhead view of a construction site for the development of several office blocks and apartments

In the current economic climate we have seen lenders take a more cautious approach with regards to the gearing that they are prepared to offer on senior debt finance. Developers seeking development finance are therefore now looking for ways to bridge the gap between the debt finance they are able to secure and the capital that they are prepared to invest (equity). Mezzanine finance is a popular option to achieve this but what exactly is it and in what circumstances might it be appropriate?

What is mezzanine finance?

Mezzanine finance forms part of the 'capital stack' and sits between senior debt and equity. Typically mezzanine finance will make up an additional 15-30% of the debt proposition leaving the developer to contribute the final 10-15% of funds required.

Diagram of the capital stack, which contains senior debt, mezzanine debt, preferred equity and common equity.

In sitting behind the senior debt, as the diagram reflects, mezzanine finance is a riskier proposition for lenders. Should the scheme encounter problems and fail the mezzanine lender would have to wait for the senior debt to be paid first before receiving monies owed. This is reflected in the interest rates which typically range from 12%-25%.

Why is mezzanine finance a popular consideration?

Having mentioned the typical interest rates that mezzanine finance can attract, you may wonder why a developer would look to take on this debt. There are a number reasons:

  • Retain capital. By securing further debt funding the developer is able to diversify their capital so as to enable other schemes.

  • Retain ownership. If a developer doesn't have the funds to bridge the gap between senior debt and the total cost of the project, the only other option is to give away part of the equity, and therefore a percentage of the future profits that the scheme could generate. Given that mezzanine finance is typically a fixed rate, this may be deemed preferable to giving away an uncapped profit slice.

  • Deferred interest. Generally mezzanine finance is added to the balance of the loan and then repaid at the end of the term rather than on a monthly basis, when the asset is either refinanced or sold.

  • It is treated as equity on the balance sheet. This means that the interest is tax-deductible.

What factors need to be considered?

In order to understand whether mezzanine finance is an appropriate solution, there are a number of factors to consider:

  • Increased risk. With an increased debt leverage comes an increased risk to the developer. Should a scheme falter there will be the looming issue of repaying the debt within a fixed period. This could prove costly to the developer.

  • Experience. In mitigating risk, the lender will want to know that there is a good track record of the developer and all other involved parties in delivering the scheme. This can count out developers that are new to either property development as a whole, or the size of the current scheme they are seeking funding for. The same can also be applied to the contractors for the scheme.

  • Senior lender approval. Because the debt structure is being made more complex by the introduction of mezzanine finance, senior debt lenders will need to approve the mezzanine lender. In the event that the scheme defaults, the lenders will need to work closely together in ensuring the necessary outcomes are achieved.

  • Viability of the scheme. Lenders will expect there to be a developer profit, after finance in the region of 15-25%. Factors that will be taken into consideration may be the location, costs, saleability, and future revenue. Riskier schemes, will generally not be appealing to mezzanine lenders. This is particularly pertinent in the current market.

  • Planning needs to have been obtained. Mezzanine lenders will be looking to mitigate any potential risks, and therefore wont want to entertain potential planning issues.

  • Additional Fees. The developer will need to factor in that there will be a duplication of fees in order to secure the additional funding required.

  • Loss of the upside from a scheme. By securing mezzanine finance, and therefore an increased debt leverage, there is reduced equity for the developer. Therefore the future upside to a scheme could effectively be forgone in place of the debt finance. This will need to be weighed up against the benefits of retaining capital for other means, as already discussed.

How can we help?

Montpelier Private Finance has an established track record of securing mezzanine finance for clients. Even in these challenging times we are able to secure 90% loan to cost (LTC) / 75% loan to gross development value (LTGDV) (lower there of) for our clients.

We have whole of market access and established relationships with a large number of lenders. Importantly, we also know which senior lenders partner with respective mezzanine lenders, in order to secure the keenest blended terms.

If you have a scheme you wish to discuss then please get in touch.

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