Written by: Sam O'Neill & Sam Hodgson
Traditionally, property developers use a combination of their personal capital and the finance available from banks or specialist lenders to fund their projects. However, there are times when lenders do not provide the necessary funding required for property developers to complete their development.
Due to the reduction in senior lending in recent years, it has become commonplace for there to be a shortfall between the budget and the total cost of development. This has become a frequent problem for property developers. 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.
In the event that there is a shortfall in funding, mezzanine finance provides an option for property developers to source further finance to ‘plug’ the gap.
Mezzanine financing acts as a second charge behind the main lender for the development. Providing additional funding, it allows property developers the freedom to minimise the amount of personal capital tied up in a project. This enables developers to invest in multiple development projects at the same time.
The majority of mezzanine finance providers will offer up to 20% of the gross development value. Therefore, the portion of funding is usually as follows :
Mezzanine finance is used by property developers when there is a shortfall in funding. This is when the property developer does not have sufficient funds to complete their project.
Mezzanine funding is usually required to be invested into the development on the first day of the project to contribute to the purchase. Therefore, it is advisable to contact a specialist property finance broker to source the best deal available.
Mezzanine funding can be used for a variety of different types of building projects, and property developers regularly use it:
Mezzanine financing differs from other types of loans because of the flexibility it affords the borrower. Through mezzanine funding, borrowers can secure the necessary funding and arrange a repayment plan that suits them.
Mezzanine loans are a popular source of finance:
It is important to note that mezzanine loans are provided when the lender can see a high chance of return. This is because mezzanine finance providers take on a certain amount of risk that other lenders do not.
As a result of the additional risk, mezzanine finance typically will have one or both of the following:
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 is available, the more they can take advantage of investment opportunities, which ultimately creates more avenues for additional income.
Although the majority of mezzanine finance borrowers are property developers, mezzanine loans are not available to all developers. Mezzanine finance providers restrict their lending to experienced property developers with a strong portfolio of successful projects. This is to ensure that the probability of repayment is high.
As a result of this, mezzanine finance providers rarely offer mezzanine loans to new or inexperienced property developers. This is because it is too risky for a lender to provide additional finance to a developer that has no experience or track record of successful projects, as the probability of repayment is low. In the unlikely event that a mezzanine finance provider grants a mezzanine loan to an inexperienced developer, it is likely that the interest will be a lot higher than a standard mezzanine loan.
An alternative route to source finance for new or inexperienced property developers is through a specialist broker to arrange a joint venture. This is where an experienced property developer or high net worth earner invests in the inexperienced property developer’s project.
Arranging mezzanine finance without professional assistance can be a long and drawn-out process with no guarantee of success. This is because almost all mezzanine finance providers solely deal with professional finance brokers in the financial service industry. When developing a property, organising adequate finance can be lengthy and complex. 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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