Development finance provides established developers and construction companies with the opportunity to borrow up to 80% LTV against all types of development projects. However, is not uncommon for developers to set their sights on 100% LTV funding, in order to cover all project costs without dipping deeply into their own capital.
This is where a secondary facility called ‘mezzanine finance can help. But how does mezzanine finance work and who is it suitable for?
What is Mezzanine Finance?
Put simply, mezzanine finance is a secondary financial product designed to ‘bridge’ the remaining gap left by the primary funding solution. Where a lender is willing to offer a 60% to 80% LTV loan against a development or construction project, mezzanine finance could be taken out to cover the remaining 20% to 40% accordingly.
Mezzanine finance is issued as a second-charge product, which means it sits behind the primary loan (first-charge development finance) in terms of priority. This means that the development finance loan is repaid first at the end of the project, followed by the mezzanine finance.
It also means that in the event that the project fails, the initial development finance loan takes priority once again. Mezzanine finance (like all second-charge loans) is therefore considered higher risk than a first-charge loan and is typically only issued to experienced developers with an established track record.
When is Mezzanine Finance Useful?
The basic principles behind mezzanine finance are fairly straightforward. For construction companies and developers to undertake multiple high-profile projects at the same time, they need to cover as many costs externally as possible. The more of their own capital is tied up in any given project, the less they have on hand to pursue other projects and ventures.
Mezzanine finance gives developers in a strong financial position the opportunity to cover up to 100% of all project costs, without using their own money. As with development finance, no monthly repayments need to be made during the term of the loan. The full balance is repaid on an agreed date in a single lump sum payment, helping the developer maintain optimum cash flow throughout.
The maximum LTV available with any first-charge development finance loan will always vary from one lender and product to the next. Where it is only possible to borrow say 60%, the remaining 40% could call for a huge injection of capital from the developer.
With mezzanine finance, this full 40% can be sourced externally and repaid at a later date with comparatively low borrowing costs.
Where is Mezzanine Finance Available From?
Mezzanine finance can be sourced in two ways. One option is to take out a development finance loan and then seek a top-up facility from a second lender. Great deals can be negotiated with mezzanine finance specialists, but taking out two separate loans with two different lenders inherently means two sets of borrowing costs (administration fees, arrangement fees, brokerage fees, exit fees, and so on).
The alternative (and almost always more cost-effective) option is to take out both facilities with the same lender. Two products are provided to cover up to 100% of the project’s costs but are effectively treated as one unified facility by the issuer.
This brings the benefit of one set of borrowing costs and the simplicity of only having to deal with one service provider. Not all lenders offer this combined service, but it is usually the preferable option for developers, where available.