Mezzanine finance, also known as junior debt, is a borrowing option for property developers who require additional funds to complete a project. The loan-to-value ratio provided by senior lenders typically caps out at 65% which means the borrower needs to cover the difference. However, developers may be reluctant to have all of their available equity invested in one project or to bring in a joint venture partner.

Mezzanine finance is a viable alternative to make up this shortfall in funding from the senior lender. It covers up to 90% of the total development costs as a subordinated debt piece that is secured by a second mortgage over the property. Mezzanine loans allow developers to protect their cash flow by taking long-term debt rather than increasing their equity. Mezzanine funding can also be raised relatively quickly and the developer retains control over the project as opposed to joint venture equity.

A mezzanine loan is essentially a hybrid of debt and equity that sits behind the senior debt facility in the capital stack. Given its subordinated or second ranking position, the lender is bearing more risk and therefore mezzanine loan interest rates are much higher. For construction, mezzanine finance ranges from as low as 15% per annum up to 30% pa for higher risk projects. While this is more expensive than conventional loans, it provides developers with much-needed capital so the project can proceed.

In order to secure mezzanine finance, the developer will typically be required to have de-risked the project as much as possible, such as presales, final construction costings being contracted and the senior debt being fully approved. This style of loan generally does not occur until the project is ready to start construction. If the developer demonstrates they have minimised the risk and achieved “shovel ready” status, mezzanine funding can typically be provided at a cost of 22-24% pa.

A property development project may be unable to proceed without additional funding from a mezzanine lender. HCP can facilitate both the senior loan and the mezzanine finance which helps to minimise delays with construction. For example, HCP could provide a $6 million senior loan at an interest rate of 7.25% pa and then cover the funding gap with a $1 million mezzanine loan at 18% pa. The developer only has to deal with one lender while increasing their borrowing potential.

Mezzanine debt interest rates are much higher than senior debt for construction financing because they carry a greater risk to the lender, but the blended cost of funds generally won’t be a significant burden on the developer’s balance sheet. The injection of mezzanine capital could easily provide an increased return for the developer which outweighs the expense of higher interest payments. Mezzanine loans can also be replaced later with a lower cost facility such as residual stock.

Mezzanine finance from HCP is an ideal solution for property developers with multiple projects in the pipeline. They can get access to capital above what senior lenders are willing to fund without trading a substantial amount of equity. By minimising the personal equity required for a single project, developers have the flexibility to use it elsewhere and diversify risk. Mezzanine funding helps to bring your project to market sooner and allows you to move forward with new projects even before it has settled.

Mezzanine loans make it simple to determine exactly how much equity you want to put into a project. By preserving their personal equity, developers can take on a greater number of projects at the same time which can also open up further revenue streams. Speak with the experienced team at HCP to learn more about the benefits of a mezzanine loan for your next property development project.