How mezzanine finance can help property developers fund projects

Covid-19 has brought tough trading conditions, but despite the challenges, I am busier than ever arranging funding for property developers. It seems as if there are lots of property developers out there seeking finance and mezzanine finance can be one solution.

Since 2016, developers have put their plans on hold for various reasons, including the uncertainty surrounding Brexit and the 2019 elections.

A majority Government in December 2019 gave them a little more confidence to proceed. However, any projects came to a grinding halt with the first lockdown in spring 2020.

Now, I sense that developers feel they can’t keep holding back, worried by uncertainty and lockdowns.

Instead, they feel it’s time to start moving ahead with projects and, as a result, many are now looking for finance.

FINDING A FUNDING DEAL

The challenge is to find a great funding deal. However, many developers are finding it hard to find a deal from their high street bank.

Averse to real estate lending right now and wading through a rush of fraudulent loan applications, high street banks are often unable to offer property developers the funding deals they need.

So, what should property developers do when their high street bank can’t help and they don’t have as much cash as they would like? Well, there are a number of finance options they could look at. Mezzanine finance is one solution that might be worth considering. However, it’s important to know what it is and how it works.

WHAT IS MEZZANINE FINANCE?

Mezzanine finance is a specialist funding product for property finance. It makes up the shortfall between the senior debt finance (the amount of funding a lender is providing) and the equity finance (the amount of money the developer is injecting into the project).

Consequently, mezzanine finance can be a very useful funding option to help developers get their project done.

It’s available through specialist lenders and is likely to only be available to professional property developers who have previous experience rather than first-time developers.

HOW DOES MEZZANINE FINANCE WORK?

There are occasions when the senior debt finance plus the funds being injected by the developer are not sufficient to enable the project to proceed.

This can happen when, for instance, a developer has funds tied up in another project which may be completed but not yet sold.

As a result, developers can miss out on great opportunities simply because there is a shortfall in available funds. Whilst this can be very frustrating, mezzanine finance can offer the perfect solution.

Most senior debt lenders will typically go up to a maximum of 70% to 80% of the total cost of the project (including the purchase price, development costs, interest charges and professional fees).

This means the developer must find 20%-30% of the total cost of the project as a cash injection. But what if a developer doesn’t have that amount of cash available? What if for instance, they only have 10%?

AN EXAMPLE OF HOW MEZZANINE FINANCE CAN WORK.

Say you are undertaking a development and the total cost of the project – including the purchase of the land, development costs, professional fees and the interest on the loan comes to £3 million. And let’s assume the GDV or end value of the project is £4 million.

In other words, it will cost you £3 million to carry out the project. You sell it for £4 million. Leaving you with a profit of £1 million.

Based on these numbers, the maximum amount of senior debt finance available is likely to be in the region of £2.4 million which is 80% of the total cost of the project and 60% of the GDV.

Therefore, in this example, you will have to inject £600,000 of your own cash to enable the project to move forward. i.e. £2.4 million of senior debt finance plus £600,000 of cash equals the total cost of the project – £3 million.

But let’s assume you only have £300,000 in cash available. That being the case, you have a shortfall of £300,000. i.e. Cash needed of £600,000 less cash available of £300,000 equals a £300,000 shortfall.

This shortfall can be made up using mezzanine finance as follows:

Without mezzanine finance:

Total cost of project = Senior debt finance + Mezzanine finance + Cash injection required

£3 million = £2.4 million + £0 + £600,000

With mezzanine finance:

Total cost of project = Senior debt finance + Mezzanine finance + Cash injection required

£3 million = £2.4 million + £300,000 + £300,000

In other words, while the senior debt finance remains at the same level, the introduction of mezzanine finance makes up for the shortfall in cash and thus enables the project to proceed.

And that is the difference mezzanine finance can make. When there is a shortfall in the cash you have available, mezzanine finance can be used as part of the overall funding solution. Consequently, it can have a vital role to play.