Essentially mezzanine finance is a type of loan or finance for experienced property investors, that works differently and is a more complex way to fund property investment.
It’s usually used to fund a building or property project, and sits in between the top, or senior, priority debts, and a second charge on the asset. That means that a client may have gotten funding from an initial lender for a set amount that cannot be extended or increased, and secure that amount against a piece of land or a property, before then agreeing further mezzanine finance.
Where the mezzanine finance comes in is somewhere in between, with a mix of secured debt and equity finance. This means that, for example, a client may take out a £100,000 development loan, but require a further £50,000 to be able to complete the project. A Mezzanine finance provider would agree to provide that extra £50,000 for a share of, say £25,000 as a second charge loan against the development, and then £25,000 in exchange for a share of the profit.
It is a more patient form of finance, and Mezzanine finance can often be extended, to an extent, as and when needed as long as the project remains on track and hits certain targets, at which point further capital would be released. Furthermore, Mezzanine finance can also be used so that a borrower doesn’t have to raise as much on a deposit.
So, for the question, what is Mezzanine finance? It’s a complex form of property finance. For the question does it work? The answer is yes, however, it depends on your circumstances and experience whether it would be right for you.
How does mezzanine finance work?
In its basic format, Mezannine finance is used in property development or investment where a borrower needs to arrange further finance, however, can’t get further funding from their senior debt provider, then a Mezzanine financing provider may step in.
In most scenarios, they’ll offer a second charge loan, which means that if the development or company goes into liquidation, they’re second in line for claiming their money back on the asset secured against the loan (mostly either a property or land). As well as a second charge loan, they’ll quite often ask for a share of the profits once the project is completed.
Although they may not always ask for equity, it usually means higher interest on the loan.
Why use mezzanine finance and its uses
If you’re in a position where you need quite quick finance and can’t get it from your principle lender, then you’re able to approach a Mezzanine financing company who can provide the capital you need.
Theoretically, Mezzanine finance can be used for most things, including business growth, buy outs and share purchases. In property, however, it’s usually used to complete projects, buy materials, expand a project or to reduce the burden on a borrower to raise a large deposit.
Debt and equity vs mezzanine
Generally speaking, when you take out finance, and especially in property, you have two types of loan.
Firstly, you have debt, which means that you take out a fixed amount for usually a fixed amount of interest payable over a pre-agreed amount of time.
Secondly, you have equity finance where an investor effectively provides you with the required finance in exchange for a share of your profit, or a share of a business. It can otherwise be known as joint venture finance.
Where Mezzanine finance fits in is in between these two types of funding. It comes behind debt equity in the sense that it would be the second priority debt should you fail to repay, and it fits behind equity finance as it will usually offer you some of the funding in exchange for a slice of your profit.
Example of a Mezzanine loan
Let’s say, for example, that one of our clients would like to purchase a commercial property that is valued at £1 million. The property generates £100,000 per year in rental income.
The client qualifies for an initial commercial loan, or mortgage, of £600,000 with their deposit of £150,000. That means that the client is £250,000 short of the overall cost of the property.
The client could, in this situation, apply for £250,000 in Mezzanine finance from a third party mezzanine loan company. In exchange, the mezzanine finance company would like 5% in yearly interest, as well as 5% of the rental profits.
Mezzanine finance providers
As an experienced broker, we work with a wide range of Mezzanine finance lenders that can give you funding.
We work with many lenders and companies that you wouldn’t usually have access to through traditional routes, such as pension funds, foreign investors, foreign banks, investment banks and private investors. We also work with a number of more traditional lenders that can offer you good terms.
Because we have a number of exclusive relationships and preferred partner arrangements, we can usually get you a better rate than you would usually be able to obtain if you applied yourself individually to these types of providers.
Because Mezzanine funding providers prefer experienced applicants, we can also help in this regard with advice and guidance. Because our panel of lenders are also experienced, they also usually offer help and advice too.
Advantages of mezzanine finance
As with any type of finance, Mezzanine debt has its advantages and disadvantages, here are the main upsides to Mezzanine loans.
- More control – When clients bring equity partners on board this can cause friction and a loss of control on the part of the developer. If you’re going through joint venture finance, for example, your equity partner has quite a large say over the project, in comparison to mezzanine.
- Charges against profits – Until the loan is completed or exited from, a lot of the interest is charged on profits. This means most of the cost of finance is a charge against profits earned rather than an additional working capital requirement.
- Flexible – Mezzanine is a highly flexible form of funding and can be used for many things with flexible terms and repayment agreements.
- Support – Most lenders offer ongoing advice and support with your project or development.
Disadvantages of mezzanine finance
As with any type of loan or finance arrangement, there are downsides too, here are a few.
- It can be risky – Leverage (borrowing money hoping to earn more than you borrowed) is considered risky. You may face significant debts and other penalties if things don’t work out.
- Criteria to work to – Lenders may ask for specialist terms, conditions, or schedules that you need to work to in order for them to ensure they see a return on their loan.
- Experience required – If you’re not experienced in your field or aren’t able to show a track record of success then there’s not a great chance that you’ll be approved.
Your rates will vary depending on your experience and the nature of your project, however, it’s sensible to expect to pay about 1% per month generally.
How do I pay back a mezzanine loan?
Because this is quite a flexible form of finance, there are a variety of ways to pay it back. You can choose to repay the debt amount or the interest monthly or annually. Alternatively, you could choose to roll the interest and repay it when you complete the finance at the end of the term.
Generally speaking, there will be a number of options presented to you at the point of the finance application.
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Is it safe?
Generally speaking, if you’re experienced in your field with a good, solid business plan and a good exit strategy then yes, it is. That being said, there’s a level of risk whenever you agree to take out a loan or finance that you may not be in a position to repay it if things don’t go according to plan.
We work with an experienced panel of lenders that are reputable, so there’s nothing to worry about in that regard.
Difference between senior debt and mezz loan
Senior debt is where a lender provides a first charge loan against an asset and becomes the ‘senior’ lender. That means, should things go wrong, they get priority on the money made from repossessing the asset, in most cases a property or land.
Mezzanine is usually the second charge debt, which means they can claim what’s left once your priority lender is repaid. Mezzanine loans will also usually look to take a cut of the profits once your project is completed.
If you’re experienced in property or business and understand that this is a complex but flexible way of borrowing capital to complete projects or expand your business, then it’s a great way to get deals over the line or service a debt over the longer term.
It’s flexible, quick and has helped a large number of our clients. Having said that, you should understand the detail of what you’re agreeing to and understand the relative downsides too.
Speak to our experts today
Pick up the phone and make an appointment with one of our finance experts today so that you can get the ball rolling and understand what you may qualify for.