Mezzanine Finance

Mezzanine Development Finance for UK Developers

Developing a residential or commercial property is not an easy proposition. If you are a developer, you already know this all too well. As the project progresses, the number of stakeholders in the project goes up as well. This leads to a sort of financial and planning chaos that few developers can manage to handle well.

Development Finance can be a simple, straightforward answer to these problems. It allows you, the developer, to borrow money as and when needed so that the project moves ahead smoothly. If your project is already backed by a primary lender, Development Finance can be even easier to obtain. In such cases, mezzanine financing can be the best-fit solution for you.

What is Mezzanine Finance?

Mezzanine finance presents itself as a niche type of property loans. As the name suggests, it is a loan that is used to ‘top up’ an existing loan on the property. Many UK developers use mezzanine Development Finance to fund various stages of the project. These include one or more of the following:

• Primary building stage
• Planning costs
• Major renovations
• Minor refurbishments
• Code compliance
• Makeover
• Value addition
• Settlement of contractual dues

As mentioned earlier, mezzanine Development Finance is used as a secondary (or even tertiary, in some cases) loan to assist the project. Let’s consider a representative example to see how mezzanine finance works.

Example

An experienced contractor wishes to undertake an ambitious development plan. The project includes buying a commercial property, renovating it in its entirety and selling it off to interested buyers. The developer estimates that a term of 8 months will be adequate to successfully exit the project.

A suitable property purchase opportunity comes in the form of an auction announced by a local bank. The bank has also proposed to finance the purchase, given that the successful bidder qualifies for the same. The developer manages to post a winning bid and secure a fair short-term auction finance deal from the bank. The bank, in this case, is the primary lender. The auction finance provided by the bank covers 60% of the purchase value. The developer is required to raise the remainder.

At this point, the developer ropes in a private lender who agrees to raise 50% of the remainder. The total purchase stake is thus divided between the bank, the developer and the private lender as 60, 20 and 20 percent respectively. The primary lender – the bank – will hold the first legal charge on the property, while the private lender will hold the second legal charge.

Why do Businesses Need an Open Bridging Loan?

There are many situations in which open bridging finance can be the most favourable option for businesses. The underlying reason that a business may choose to take an open bridging loan is the uncertainty over the execution of the exit strategy.

Let’s consider an example to better illustrate this uncertainty.

Example

Let’s say that a business currently houses its operations in a city warehouse. As the business expands, the available floor space doesn’t suffice. So, it makes more sense for the business to move to a larger, cheaper warehouse away from the business district. As the need to expand is pressing, the business may wish to immediately purchase the new warehouse property.

However, funds required for the same can only be arranged by selling the existing warehouse. This sale, again, isn’t always straightforward. The entire process may stretch over weeks, if not months. In such a scenario, the business can choose to apply for an open bridging loan, provided that the lender is satisfied with having to account for this uncertainty.

Advantages of Mezzanine Finance

Mezzanine finance brings all the advantages of Development Finance to the table.

• Flexible repayment
• Interest can be rolled into equity
• The borrower is exposed to lesser market risks

While these features are indeed borrower-friendly, there exist some that aren’t so. The reduced exposure to market risks also means that the borrower’s share in the overall profits is proportionately smaller. In addition, the primary lender’s consent may be required in some cases to involve a mezzanine lender.

Mezzanine Development Finance Repayment

When it comes to settling the loan, mezzanine Development Finance holds a unique place. There are four components to every mezzanine loan:

• The loan principal
• The interest
• The fees
• The equity (stake)

The interest, fees and equity are flexible. These can all be rolled into one another as per the Agreement in Principle (AIP). The interest is, in most cases, payable on a monthly basis. On the other hand, the loan principal and the equity are to be paid upon successful exit.