Retaining flexibility is the key to success in the ultra-competitive property development sector, and it’s vital for any property developer to remain adaptable when creating opportunities for profit. In any property development scenario a wide range of finance options is available, and the ability to utilise mezzanine finance as an additional funding source can be highly advantageous to developers that need to put together a cohesive financial structure using several funding streams.
The use of mezzanine finance is widespread throughout the property development industry, and large developments in particular often necessitate the use of mezzanine finance. It’s important to bear in mind, though, that while mezzanine finance is often an integral part of a developer’s financial architecture it should not be considered a “no brainer”; like with any other financial product, misused mezzanine finance can prove to be detrimental to a developer’s continuing business objectives. The sheer flexibility of this type of finance and the many different varieties on offer means that there’s an often bewildering number of options available to borrowers, so it’s important to consult a financial advisor before making a commitment; they’ll be able to guide developers to the correct finance product for their needs.
Mezzanine finance is a key element of many developers’ financial plans. This type of finance is used to complement other funding sources such as bank loans and capital, and constitutes an additional financial element rather than a standalone funding product. Mezzanine finance takes its name from a “mezzanine floor”, a floor that typically sits sandwiched between the ground and top floors, and is often open to other floors in the building. This reflects the role it plays in development finance: mezzanine finance is senior to equity and shares, but is subordinate to secured loans and bank finance - it occupies the middle ground, hence the name mezzanine.
Mezzanine finance fulfils a crucial part of development finance because it enables developers to “top up” their capital without providing any additional security. Mezzanine finance is unsecured, and though this makes it more expensive, it also means that it doesn’t need to be backed by assets, so borrowers aren’t limited by the value of their assets. This can be useful in many situations, and makes mezzanine finance a crucial element in many large development projects.
For example, let’s say a developer wants to buy up a block of flats for £10 million. They may only have £1.5 million of their own money, and though they can take out a development loan to finance the rest of the purchase (which will be secured against the property), they can only borrow 75% of the building’s purchase price. This leaves them with a £1 million shortfall that prevents them from proceeding with the project, but mezzanine finance can be used in this situation to provide the necessary capital. The mezzanine finance will constitute the additional £1 million deposit provided by the borrower and will enable them to complete their purchase.
Mezzanine finance allows developers to minimise the amount of capital they need to provide in order to take on a project. In the above example our developer is only putting up 15% of the property’s value, which means they’re still able to take on other projects simultaneously. They can remain flexible without becoming tied down to one particular development, which is absolutely crucial in an industry as fast-moving and complex as property development. Mezzanine finance therefore plays a critical role in enabling property developers to maintain financial flexibility.
Mezzanine finance is often used by smaller companies as a means to leverage their assets into much larger acquisitions. In our example above, the developer is still putting up a large chunk of capital in order to finance their project. However, many smaller developers might not have £1.5 million to invest in such a venture, and may only be able to provide a much smaller sum; in these cases, mezzanine finance can constitute a large percentage of a project’s total finances.
Mezzanine finance is an ideal counterpart to other lending products, and is often used in conjunction with bridging and development loans. It’s important to bear in mind that the most significant difference between these types of finance is the nature of the loans themselves; while development and bridging loans are both secured against property, mezzanine finance is not. While this allows borrowers to easily top up the capital they need for a development project, it does represent a riskier proposition for lenders; they have no assets with which to reclaim their money if the borrower doesn’t pay them back, and will struggle to recoup any losses. Therefore, mezzanine finance providers need to offset this risk with higher costs, in order to guard against the danger of default.
Mezzanine finance providers understand that the additional burden of a high interest rate can prove detrimental to a developer, especially one that’s already maintaining several other loans, and so a loan structure is arranged that doesn’t place undue stress on a borrower’s bottom line. This is often achieved by structuring the types of repayment the borrower makes; instead of simply servicing the loan monthly, mezzanine financier also accept “rolled up” loan payments, which take a loan’s total interest and add it to the final repayment. This allows developers to minimise the impact of mezzanine finance on their bottom line, instead deferring all payments until they’re in a position to do so (i.e. when they’ve sold or refinanced their property).
Mezzanine finance constitutes an important part of any property developer’s toolbox, and should be considered at every stage of a project proposal. Although mezzanine finance does contribute to the overall cost of a project, it can also be used to enable development that would otherwise be beyond reach, and as such can be considered a vital element of any property developer’s strategy. Mezzanine finance is a fast, flexible way for property developers to achieve their development goals without becoming overcommitted, and allows them to retain both flexibility and profitability.
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