Fox Davidson are a multi-award-winning mortgage broker. We secure finance for global clients on property and land in the UK. One area of finance we specialise in is property development finance.
Property development finance can be made up of several parts, a 1st charge lender also known as the senior debt lender and a 2nd charge lender also known as the mezzanine lender.
What is mezzanine finance?
Mezzanine finance is a property development loan that is secured by way of a second charge, behind a senior debt lender. Mezzanine finance is loaned at a higher loan to value than the senior debt. Mezzanine finance is more expensive than the senior debt due to the increased risk that comes from lending at a higher loan to value and as a second charge on a development. A mezzanine finance lender will typically release funds on day 1, alongside the senior debt lender and will take repayment of their loan after the senior debt lender has been repaid.
Why is mezzanine finance used?
Mezzanine finance serves a purpose because it allows property developers to put less of their own cash into a development, this can have many benefits. If a developer does not have the cash, then mezzanine finance is the difference between a development happening or not. If a developer does have the cash, they may choose to utilise mezzanine finance to allow them to retain more of their own funds as contingency or to earmark their funds for another development site.
What is the maximum loan to value for mezzanine finance?
Many prime mainstream property development lenders will only lend up to 65% to 70% of costs (land, build costs and professional fees) and subject to a maximum of 60% of the gross development value (GDV).
A mezzanine funder can lend additional funds up to 95% of total costs. This would require a developer to only put in 10% of the total costs.
The total costs include the purchase price, the build costs, all professional fees and the stamp duty.
Mezzanine Finance Calculation
Below is an example of a how mezzanine finance works in practice:
Purchase Price £1,500,000
Build Costs £800,000
Professional fees & Stamp duty £45,000
Total Costs £2,345,000
The senior debt lender may fund 50% of the purchase price, 100% of build costs and fees, subject to max loan of 70% of total costs.
Purchase Price £1,500,000 x50% £750,000
Build Costs £800,000 x100% £800,000
Professional fees & Stamp duty £45,000 x 100% £45,000
Total funding £1,595,000 = 68% loan to costs.
With a GDV of £3,600,000 their loan would represent 44% loan to GDV.
A mezzanine finance lender will now be able to top the lending up to 90% of total costs and subject to 75% of the GDV. This would release an additional £515,500. The total loan from both lenders is now £2,110,500 and therefore 90% of loan to costs and 58% of GDV.
The developers cash input has changed from £750,000 to £234,500.
How is the Interest calculated for mezzanine finance?
The interest on a mezzanine finance loan may be calculated in two ways. The first is compound interest and the second is simple interest. Compound interest is more expensive because the interest from the previous month is added to the loan and the interest for the next month is calculated on the new loan amount for that month. The loan amount increases every month and the interest is calculated on the increasing loan amount, every month.
Simple interest is fairer and is calculated on the original loan amount only. Although the interest is added to the original loan and will therefore increase the amount you have to pay back, it does not compound and can save a developer a lot of money in interest.
What are the typical terms for mezzanine finance?
The typical terms for mezzanine finance are:
- 95% loan to costs day 1
- Up to 75% of GDV
- Interest rate of 1.5%pm
- Lenders fee of 1.5%
What amount of profit do lenders require a developer to make from a development?
Most lenders require the developer to make at least a 20% profit, some will require at least a 25% profit.
How quickly can mezzanine finance be arranged?
This will depend on the lender but assuming the mezzanine finance can ‘piggy back’ off of the professional valuations of the senior debt lender then it is possible to secure mezzanine finance within a few weeks.
Can additional security be used?
As with senior debt it is possible to cross charge other security other than the subject development site. The subject development will still need to be profitable.
Contact us to find out more about Mezzanine finance.