Mezzanine Finance for Property Development

Even for experienced developers, the wide range of property development finance options can be perplexing. There are often multiple ways to raise the funding you need and it’s not always clear how they differ or which is best for you.

In this article, we’ll discuss how mezzanine finance works, the advantages and disadvantages, and alternative methods of achieving a similar result. If you decide to apply, we’ll explain how to improve your chances of success.

We’ll cover the following topics…

What is mezzanine finance?

In the context of property development, mezzanine finance is a type of funding a developer might seek to top up the amount they have an agreement to borrow from another lender. It’s a second-charge debt (since the existing debt – the senior debt – is the first charge).

In the same way that a mezzanine level of a building fills a gap between the ground floor and first floor, mezzanine finance fills the gap between the funding they have secured from their senior lender and the capital they are willing to put into a project themselves.

So, if a project will cost £1 million in total, the senior lender may be willing to provide £700,000. If the developer wants to put in just £100,000 of their own capital, they might seek £200,000 in mezzanine finance.

Uses for mezzanine finance

You can use mezzanine finance for almost any type of property development, including residential, commercial, student, and mixed-use. It’s usually chosen as a way to keep your capital commitment on a project low because:

• Raising capital upfront will be time-consuming or impractical
• You have capital available but wish to retain it to fund other projects

How it works

Before seeking mezzanine finance, you’ll need to secure a senior lender. They will usually fund 65-75% of the total cost of a project. Then, you can apply to mezzanine finance providers. They will usually lend around 15-20% of the capital required, leaving you to contribute 10-15%.

In exchange, most mezzanine lenders will take a share of the profits of the project – usually 30-35%. In certain cases (particularly those that are seen as higher risk), they might require up to 50%.

Sometimes, lenders won’t require a share of the profits but will charge a higher rate of interest on the loan. Rates are decided on a case-by-case basis, typically starting at around 10-12%, though they can be much higher.

How much you can borrow for property development

Mezzanine finance for property development can be extremely flexible with regard to borrowing amounts.

• Some providers are focused on smaller loans, e.g. from £75,000
• Others focus on larger loans, e.g. between £1 million and £15 million
• Several have no maximum borrowing amount

However, lenders will usually cap your borrowing at between 65% and 75% of the gross development value (GDV), meaning the total forecast selling price of the completed project.

They will also typically only top up your borrowing to a maximum of 90% of the project costs, requiring you to put in at least 10% of the capital. Occasionally, they might accept alternative security, allowing you to borrow 100% of the project costs.

Mezzanine finance providers

Mezzanine finance is an extremely specialist funding type that isn’t offered by mainstream lenders. There are around 50 specialist lenders in the UK and Europe, who mostly deal with a specific niche of the market, for example:

• Some providers only work in a certain geographic region
• Some providers finance only residential developments, or only commercial developments
• Providers may have a maximum term of 12, 24, or 36 months

While you can research the lenders individually yourself to ensure that you’re approaching the best option for your project, a quicker and more reliable route is to go through a broker with expertise in this area.

How to apply

The following three-step process will give your application the best chance of success.

Step one: Create your written proposal

Lenders will primarily make their decision based on the viability of your project, the financials, and their belief in you as a developer. Therefore, your proposal should include:

• Details of the site or property, including why you’re buying it and for what price
• Your target market and how this project will appeal to them
• Clear, detailed, and realistic numbers, including gross development cost (GDC) and gross development value (GDV)
• Details of your senior debt and lender
• Evidence of planning permission
• Details of your industry experience and track record

Step two: Find a mezzanine finance broker

Your broker will use their knowledge of the market to ensure that you’re approaching a lender who can offer the best rate for your project, and they’ll help you tailor your proposal to their requirements.

A mezzanine finance broker’s previous experience working with a specific lender can add significant value as they know exactly what that lender is looking for and which information and details you should include. So, it’s important to find a broker who specialises in projects like yours – make an enquiry and we’ll match you with an advisor who meets this criteria.

Step three: Arrange your financing

You’ll approach a lender through your broker and, if they’d like to be involved in your project, your broker will negotiate the details. The exact terms, profit share, and rates will all be tailored to you.

Benefits

The main benefit of mezzanine finance is that you can increase your leverage and reduce your personal capital commitment. That allows you to get the project off the ground quicker and potentially run more projects simultaneously.

By minimising your contribution to the project cost, you may be able to achieve a higher rate of return on your investment. Plus, the blended rate for your senior debt and mezzanine debt may be lower than the rate you could get from a single lender.

Considerations

Since mezzanine finance is designed to maximise your borrowing, it elevates the level of risk involved. If the total sales price of the project is lower than expected, there is the possibility it will not be enough to repay the loan, leaving you personally liable to pay the difference.

The interest rates for mezzanine finance are often higher than other borrowing methods and there can be more fees involved. Plus, usually, you will need to be willing to sacrifice some of your profits, which not all borrowing methods require.

Alternatives

One alternative to mezzanine finance would be to contribute more capital yourself, which you could raise through selling off other assets, for example. However, the purpose of mezzanine finance is to keep your commitment low.

Here are some of your other options that share that goal.

Senior development finance

If you’re looking for mezzanine finance because your senior lender cannot provide all the funds you need, you might first consider approaching a different lender about the senior debt. They may be prepared to lend you all you need or meet you in the middle.

For example, if your senior lender can only provide 65% of the total project cost and you only have 15%, one option is to find a mezzanine lender to provide 20%. Another option is to find a different senior lender who can provide 85% – or 80%, if you can raise an additional 5% yourself.

Stretch senior development finance

This works in a similar way to mezzanine finance, except that the additional loan is with the same lender as your senior debt. By dealing with just one lender, you can minimise the fees and legal work involved. However, this lender won’t necessarily be able to offer you the best rate.

Joint venture development finance

This option allows you to reduce your capital commitment to zero, as the lender will provide 100% of the project costs. In exchange, you’ll have to sacrifice more of your share of the profits. Joint venture development finance lenders usually require a 40-50% share. However, this can be a good way to run multiple projects at once with less strain on your personal funds.

Business loan

If you have the means to meet the repayments on a business loan in addition to your development finance debt, you might be able to use this form of borrowing to cover any extra funds you need.

Just keep in mind that business loans are unsecured, and one of the implications of this is that interest rates can be high compared to some of the other options.

Get matched with a mezzanine finance broker

Working with the right mezzanine finance broker can significantly improve your chances of securing the funding you need at the rate you can afford. We work with numerous brokers in this field and offer a free service to match you with the one we believe is the best fit.

To take advantage of that service and connect with a broker for an initial conversation, you just need to provide us with some details about you and your project. To do so, you can call us on 0808 189 2301 or make an enquiry online.