Mezzanine Finance and Funding

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    What is Mezzanine Financing?

    Mezzanine financing is a form of debt finance that sits behind senior debt (normally on a development loan) and reduces the amount of common equity required by the borrower. This enables the borrowing company to leverage at a higher loan-to-value and therefore maximises the return on the equity investment made by the existing shareholders.

    There are a number of mezzanine lenders in the market, but it is a specialist area of debt financing.

    Why is it called Mezzanine Financing?

    Mezzanine loans get their name because they sit between the senior loan and the equity requirement and fulfil a funding gap. This forms part of the mezzanine financing structure for both debt and equity.

    As mezzanine funding sits behind senior debt holders, it helps provide a better return for the equity stake proportion and should be a consideration for the company’s capital structure.

    Why do companies use Mezzanine Financing?

    Mezzanine debt is an important tool in the corporate finance armoury as it provides leverage to a traditional business loan. It provides additional capital within the debt and equity structure. Therefore, it gives the borrower a better return by way of IRR on the equity finance portion, as it provides increased cash flow that can be invested into others projects.

    Equity financing is usually harder to source, with senior debt being the easiest, followed by mezzanine finance.

    How does mezzanine finance work?

    Mezzanine financing is a debt that is usually drawn down on day one together with the senior lender debt to acquire the land/site. The senior lender then provides the debt for the build costs, which are paid in line with the monthly valuation, providing the working capital to fulfil the build packages within the contract sum analysis.

    Established companies that really understand the importance of their Internal Rate of Return (IRR) utilise this form of debt to provide the best return on their equity. Interest is not serviced; it is usually offset and rolled up, becoming payable at the end of the project.

    Mezzanine finance has become more readily available over the last decade as the complexities of mezzanine debt become more understood. It undoubtedly requires a high skill set to manage, which the team at One Commercial Loans can offer.

    How does Mezzanine Funding work in commercial property and development?

    The mezzanine debt works in the same way across all commercial and residential property developments. Individual mezzanine finance lenders will have varying appetites depending on the asset type, the experience of the developer, and the location of the asset.

    The mezzanine financing sits behind the senior debt, and a deed of priority is entered into, protecting all parties but in particular the first lender’s debt position. As the mezzanine finance carries a higher risk, there will be higher interest payments charged to the facility, together with facility arrangement fees.

    Both the interest and fees are tax deductible. The senior debt is repaid in priority to the mezzanine debt before the borrower sees any return on their equity finance. All these forms of debt and equity help form what is known as the capital stack.

    Pros and cons of Mezzanine Finance

    The pros of using a mezzanine loan are that you can maximise the return of common equity financing, in that the developer’s IRR will be higher as it frees up much-needed business cash flow, which can be utilised in other projects.

    Additionally, there are no ongoing interest payments, as the interest is rolled up, making this form of debt finance invaluable. Ultimately the more capital you can raise, the less equity that will be required. You are basically using the leverage to convert debt into a smaller equity requirement.

    The cons of mezzanine finance are that the cash interest payments are higher due to the greater risk for the lender. It is important that you plan the project in detail so that you reduce the chances of both cost and program overruns.

    This means that you maximise the opportunity of using mezzanine debt by producing an increased equity return for the existing owner’s balance sheet.

    Mezzanine finance is not for the faint-hearted, but if you are on your top game, it is the best way to leverage both your debt and equity positions.

    What are the lending criteria for Mezzanine Financing?

    This varies depending on market conditions and also the specific lending criteria of different mezzanine lenders. Mezzanine finance can be obtained up to 75% loan to GDV and 90% of the loan to cost, including interest.

    Mezzanine financing inclusion means it is one of several funding options. However, it can reduce the equity element by a significant amount and ensure you have enough money for the project to go ahead.

    Obviously, the increased risk of mezzanine finance means that the lender carries out more robust due diligence and will focus on the borrower’s credibility, asset type and location – the latter to prove the demand is significant enough to increase the interest of potential buyers.

    How are debt Mezzanine loans structured?

    Mezzanine financing is usually structured in a ring fence SPV. Gone are the days of traditional bank debt, with many alternative ways of providing a hybrid financing solution in today’s market.

    Senior debt from a long list of alternative other senior lenders will take a legal charge on the asset and a debenture on the SPV. Sometimes they will also take a share charge. The mezzanine financing will then sit behind the senior debt and also take a legal charge on the asset together with a debenture on the SPV and, again, sometimes take a share charge.

    After the mezzanine financing sits the developer’s common equity. The priority of the debt and equity will also be repaid in this order.

    Are Bridging Loans and Mezzanine Loans the same?

    The difference between bridging loans and mezzanine funds is that the former is a first legal charge position and is a form of short-term finance for up to 12 months. Mezzanine financing is a second legal charge position and is usually for 18-24 months duration.

    Use One Commercial Loans for Mezzanine Finance

    One Commercial has access to mezzanine finance providers and lenders who can help in sourcing the best debt for your circumstances and the relevant interest rates. We can do all the hard work for you, giving you the opportunity to achieve the best returns on your equity.

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    About One Commercial

    One Commercial have over 100 years of property experience. At One Commercial we like to use a “one stop shop” approach, utilising the whole market to support our clients in a wide range of property related finance.Their job is to make sure that they have done the hard work by matching your situation to the right commercial lender and for the best deal.

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