Mezzanine Finance is a debt and equity hybrid which enables a lender to convert the debt into equity. Mezzanine finance is a second charge debt, is higher risk, and subsidises a shortfall in cash at hand. We will break down this type of financing into easy-to-understand terms, focusing on time frames, the costs involved, and why you would opt to use mezzanine financing for your property development project.
Mezzanine Finance is a second-charge debt that is used by property developers to access additional funds when they need more capital to complete a project. This type of finance helps to provide a bridge between the funds offered by a lender and the capital of the borrower. The party providing the mezzanine finance would take a second charge over the development, similar to how a second charge loan providers would secure their second charge behind the mortgagee assuming there is adequate equity in the borrower’s home.
Typically, mezzanine finance would be accessed for three main reasons:
Once accepted, the money may be made available at the beginning of the project if it is needed as a deposit, or if it is to be used to purchase a site. Alternatively, it may be released during the project when it is needed by the developer. This flexibility is one of the key benefits of this type of finance. A usual mezzanine finance arrangement would see the senior lender provide 70% of the development funding, while the mezzanine finance lender would provide an additional 15-20% of capital, with the remaining balance coming from the developer.
The mezzanine finance lender secures the funding by taking a second charge on the property development. This way, the lender will recover the finance provided plus interest at the end of the loan term, this can be achieved in several ways, which we will discuss in the next section. Mezzanine Finance is a short-term loan and most lenders would expect the debt to be settled within 12-24 months.
A mezzanine finance lender would look to achieve a return on investment in the following ways.
Should the development be successful, then the lender will receive interest repayments in addition to equity, regardless of whether the loan is paid back. This means that the more profitable a development is, the larger the stake the lender has in your business. The reason for this high rate of interest is that the level of risk for the mezzanine lender is also high, as it is a second charge debt that falls behind the initial senior loan. Mezzanine finance lenders usually offer very flexible interest repayment plans (monthly, quarterly, rolled up or annually).
Mezzanine finance providers will let applicants borrow up to 90% of the project’s loan to cost, providing the borrower is eligible, or up to 70% of the project’s loan to gross development value. In terms of the maximum a developer can borrow, some lenders place a cap in the region of £3m, while some lenders have no cap at all. Many lenders also have a minimum loan amount requirement that can range between £75k and £250k. In some cases, the lender may also require a personal guarantee or additional collateral to secure the loan, although this is often not a requirement and in respect of surety may only require minimal additional collateral.
Like any type of finance, most applications will be assessed individually and on each project’s own merits, but almost every lender will check for primary eligibility criteria before approving any loan.
Unfortunately, mezzanine finance can be rather complex and sometimes take a few months to arrange, as this type of loan is commonly associated with large-scale development projects, with many factors to consider. Therefore, it is recommended to expect an extended arrangement process when planning your development project.
If you are unfamiliar with any of the terms used in this article, then feel free to browse our development finance glossary for easy-to-understand descriptions and jargon free terms. Further reading and reference.
In recent years, the UK has been grappling with a severe housing crisis, with millions…
Build to Rent is a distinct asset class in the PRS (private rented sector) as…
Heat pumps aren’t a new phenomenon and have been around for over 150 years, the…
The Real Estate Investment Trust (REIT) was introduced to the UK in 2007 and continues…
Property trends in Scotland have differed greatly from England and Wales over the last decade,…
A development property option agreement is a legally binding agreement between a potential purchaser (developer)…