If a developer already has existing finance in place, but there is a shortfall in the funding, a mezzanine loan may be able to provide further finance to ‘plug’ the gap. This could ensure that the developer progresses the project to completion without any costly delays.
Property development often involves significant initial expenditure on land purchase, ongoing expenditure on building costs and fees for a construction period of twelve to eighteen months or more, before achieving a sale to recoup costs and crystallise any profit. The capital-intensive nature of the activity has stimulated the emergence of various lenders and lending techniques, to meet a demand from developers seeking finance to employ alongside their own capital.
Many developers employ a range of financing methods on each scheme; for example part of the land purchase price may be funded from the developer’s own capital; some borrowings will be taken with a first-charge and relatively modest loan-to-value ratio secured on the land and construction work in progress; and the remainder may be borrowed (at higher cost) from a second charge lender, and/or traded for a share in the project’s profits.
Developers have been using both ‘mezzanine’ and equity funding to finance this remaining portion of the cost of property projects since the early 1980’s. These forms of finance contribute towards meeting the shortfall between the amount of senior debt, thereby reducing the developer’s cash requirement.
Mezzanine lenders typically provide up to 20% (although may go higher depending on circumstances) of the gross development cost, for example:
• Bank: up to 70% of the total cost
• Mezzanine lender: up to 20% of the total cost
• Developer: up to 10% of the total cost
The additional finance available from mezzanine borrowing can be attractive for developers by covering costs to complete a project and enable them to minimise personal capital tied up in a project; and will also allow them to undertake several developments simultaneously.
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