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Mezzanine finance – cost, structure and is it the right solution for you?

HOW IS MEZZANINE FINANCE STRUCTURED?

Mezzanine finance is available through several specialist lenders. They work closely with the lender providing the senior debt finance and consider each project on its individual merits. However, there are some broad parameters involved in this type of funding. A look at these can help you understand how mezzanine finance is structured and whether it is the right solution for you. Consider the following…

EXPERIENCE

Mezzanine finance is a specialist funding solution. It is usually only available to professional property developers who have previous development experience. Consequently, first-time property developers are unlikely to access mezzanine finance.

SECURITY

My previous blog describes how the lender providing the senior debt finance will take security over the property development. I explain how they will take a first legal charge.

Mezzanine lenders secure their funding by taking a second legal charge on the property behind the lender providing the senior debt. An arrangement like this will use a legal document called a Deed of Priority. This sets out the agreed terms between the two lenders in the transaction.

Often, lenders offering mezzanine finance have worked closely with the lenders providing the senior debt finance on previous projects. As a result, they are usually familiar with each other’s requirements and processes. They are likely to have a pre-agreed Deed of Priority already in place which can save you both time and cost.

LOAN TERM

The loan term on mezzanine finance is linked to the loan term for the senior debt finance. This, in turn, is linked to the length of time the developer expects to complete and sell the project.

Take, for example, a project that is likely to take 15-months to build and sell The term of the facility from the lender providing the senior debt finance and the mezzanine finance will also be 15 months.

Image by ar130405 at Pixabay

INTEREST RATE

As you would expect, interest rates for mezzanine finance are higher than for senior debt finance. However, there are some rough guidelines. If you are taking out mezzanine finance as part of your funding package, expect an interest rate of 16% to 20% per annum.

Bear in mind, that while an interest rate of 18%, for example, may sound expensive when looked at in isolation, in the context of the total borrowing including the senior debt finance, the ‘blended’ rate for both the debt and mezzanine finance together usually comes in at around 9% to 9.5% per annum.

FEES

In a similar way to the senior debt lender, a mezzanine lender will also charge both an arrangement fee and an exit fee. Expect an arrangement fee and an exit fee of around 1% to 2% of the amount of mezzanine finance you want to borrow.

LOAN SIZE

The project and the amount of mezzanine finance you require will dictate the loan size. Most mezzanine finance lenders have a minimum loan size of £200,000 to £300,000 with a maximum of £5,000,000.

Consider how much cash you have available for the project? Next, have an idea of the amount of senior debt finance that you can raise. You can then work out how much mezzanine finance you are likely to require.

LOAN TO COST

The maximum they will lend against the total cost of the project is one of the key metrics for all lenders providing development finance. 90% is a typical maximum with the 10% balance being provided by you, the developer.

However, as I have already mentioned, if only 80% of the total cost of the project is available as senior debt finance, this would leave a shortfall of 10% which is the amount available as mezzanine finance.

LOAN TO GROSS DEVELOPMENT VALUE

As well as the maximum loan available against the total cost of the project, lenders consider other key metrics. They also look at the total amount of the loan as a percentage of the GDV.

GDV refers to the Gross Development Value of a project. This is the value of the development once it is completed.

As a guide, the maximum amount available will be up to 75% of the GDV. Bearing in mind that on senior debt finance, the maximum loan available against the GDV is typically between 55% and 65%, this means the shortfall will be made using mezzanine finance.

Of course, the loan to GDV is not looked at in isolation, and as I have already mentioned, the total amount of senior debt finance and mezzanine finance available will also be measured against the total cost of the project.

Therefore, as you analyse how much you need to borrow, keep these two metrics in mind (loan to cost and loan to GDV). Doing so will give you a very good idea of not only how much funding you will be able to raise, but also inform you how much of it will be senior debt finance and how much will be mezzanine finance.

VALUATIONS, MONITORING SURVEYORS AND SOLICITORS

The lender providing the senior debt finance and the lender providing the mezzanine finance work closely together. This ensures as smooth a process as possible to completion and then throughout the development.

Of course, both lenders, as part of their application process, will require a valuer, monitoring surveyor and solicitor to be involved.

The valuer has the job of valuing the property before the development has started. They then also provide an estimate of the gross development value (GDV) once the development has been completed.

The monitoring surveyor is employed by the lenders to oversee the ongoing progress of the development. They also ensure that you receive the funds you need from the lender in stages as the development progresses.

Both lenders, senior debt and mezzanine, require security by way of a legal charge on the property you are developing. Therefore, a solicitor acts for both lenders, to ensure they can register their charge on the property in question.

You the borrower are responsible for all these costs, so make sure you factor them into your budget. Ask the lenders for a quote early in the application process so that you know what to expect.

That said, to ease the process and also to save on time and cost, both lenders providing the senior debt finance and the mezzanine finance, will normally use the same valuers, monitoring surveyors and solicitors.

WHAT INFORMATION DO YOU NEED TO PROVIDE TO THE LENDER?

The information provided when applying for senior debt finance is the same as you give to the lender providing the mezzanine finance. The key information needed includes…

  • Copy of your passport as proof of identity
  • Copy of your driving licence or utility bill (less than three months old) as proof of residency
  • Personal asset and liability statement
  • CV with an emphasis on any previous development experience that you may have
  • Details of the property you are acquiring or already own – this can be a copy of the estate agent details or a historic valuation
  • Copy of planning permission
  • Breakdown of the development costs
  • Copies of plans and drawings
  • Development appraisal to include details of the GDV, a breakdown of the build costs, professional fees and all other costs

While this is not an exhaustive list, if you are able to supply as much of this information as possible, it will greatly help the lender in making an informed decision regarding your application. However, bear in mind that there may be other information the lender will ask you to provide as the application progresses.

MEZZANINE FINANCE – PROS AND CONS

PROS

  • It can make the difference between you being able to proceed with a project or not
  • It enables you to borrow more
  • You tie up less cash in the project
  • The mezzanine finance lender and the lender providing the senior debt finance will both use the same valuers, monitoring surveyors and solicitors. This gives you a saving on both time and expense

CONS

  • It can create difficulty exiting the project because the margins are much tighter if the development doesn’t go according to plan. This could be caused by cost over runs or not achieving the sale prices of the completed project. This is because the loan to cost and loan to GDV are higher when mezzanine finance is involved.
  • More expensive than senior debt finance and can therefore affect the overall profitability of the project.
  • Mezzanine lenders can be selective about the types of deals they will consider, so your deal may not be for them.

SEEK EXPERT ADVICE FROM A SPECIALIST COMMERCIAL BROKER

It is important to seek help from a specialist commercial broker. If you are considering mezzanine finance as a solution, please get in touch with us here at Funding Track.

Alternatively, the National Association of Commercial Finance Brokers (NACFB) can also help you find expert advice. They have more than 2,000 members . Contact them via their website findsmefinance.co.uk and they will put you in touch with a broker who is registered with the organisation.