Mezzanine Finance for Developers

Mezzanine Finance for Developers

9:36 AM, 6th August 2013, About 11 years ago 1

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(By Malcolm Jones of Brooklands Commercial Finance)

Despite the Banks recent profit announcements, Developers are still being frustrated by their continued reluctance to lend. When Banks are prepared to lend on development projects the percentage of costs or of the Gross Development Value (GDV) is often so low that it is not workable.

Many borrowers are now turning to Commercial Finance Brokers such as ourselves to assist with raising the total finance required.

Most property development loans can be broken down into Senior Debt loans and Mezzanine Loans. The Senior Debt element is the amount lent by the bank or finance company and this is often limited to 60% of the costs. Mezzanine finance is a second charge loan that sits on top of the senior loan and hence the name “Mezzanine”.

Mezzanine Finance

Due to the dramatic drop in bank lending to the property sector in recent years, many successful and profitable residential developments have made use of Mezzanine finance. With the Senior debt lender funding 60% of the costs the Mezzanine lender will often lend 30% of the costs, leaving a requirement of only 10% from the developer.

The finance can cover the costs of the land purchase, site and infrastructure costs, build costs and professional fees.

By using Mezzanine finance the developer is able to reduce his equity contribution, spread his risk and considerably enhance the percentage return on his own invested funds. Although Mezzanine finance is more expensive than Senior debt, there are many financial advantages.

For example:

Mr A goes for low gearing Mr B goes for high gearing
Mr A invests £200,000 in building 1 house Mr B invests £200,000 in building 6 houses
The GDV is £600,000 The GDV is £3,600,000
Finance at 50% £200,000 Finance at 90% £1,800,000
Finance cost £50,000   Finance cost at £450,000
Net Profit £150,000 Net Profit £550,000
Gross Profit 33% Gross profit 33%
Return on developers money 75% Return on developers money 275%

Because of the increased risk to the mezzanine company, they look for experience developers, good projects and a reasonable profit level.

If you require any assistance with Development finance please Click Here

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16:37 PM, 6th August 2013, About 11 years ago

Mr B has planning permission for 6 houses, whilst Mr A only has 1: surely this isn't a fair comparison? Mr A should be given 6 houses to build as well; he will probably choose to build slower and in sequence to reflect his reduced available capital, but eventually he will recycle his profits into a larger construction budget and will have no need of bank debt at all.

Remember the parable of the tortoise and the hare. Another way of presenting the figures is that Mr B only makes 45.8% per house on his money, whereas Mr A makes 75% per house. Or, Mr B makes net profit of £550K on 6 houses, whereas Mr A will make £900K, or even more because by the end he will be self-funding and will be paying nothing to the bank. In a world starved of development sites and where getting planning permission is a minor miracle, it pays a developer to build slowly and maximise returns on his limited supply of sites.

Mezzanine finance charges credit-card rates of interest (22-28%, plus very large start-up and close-down charges of around 3% of the total sum lent). This means if you have any construction delays or a delay in selling the properties, interest charges sky-rocket. Consequently developers cut their losses and accept lower prices to get the debt burden off their back, which pushes down returns: this ought to be reflected in the figures above.

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