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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”.
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.
|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.
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