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Some people see mezzanine finance as a form of last resort lending, but this is wrong. Many of our clients choose to use mezzanine finance even though they are able to fund their developments themselves. The question is, why?

Mezzanine finance is used to fill the gap between a developer’s equity and the senior debt provided by a bank. In a typical case, a developer will put up equity of around 10% of cost, the bank will lend between 60% and 80% and the mezzanine lender can make up the difference. The mezzanine is provided as part of the equity required by the bank on day one, with the bank funding the building and professional costs plus part of the land acquisition costs.

Contrary to what you may think, mezzanine funding is rarely used because a developer is short of funds. In most cases, our clients choose to use mezzanine funding even though they have the necessary cash available. Here are six reasons why:

1. To increase the internal rate of return (IRR)

By using mezzanine finance a developer can significantly increase the IRR on his investment. This is best illustrated by an example:

Typical 18-month development cycle

With mezzanine (£’000) Without mezzanine (£’000)
Gross development value (net) (GDV) 5,000 5,000
Gross development cost (including bank loan) (GDC) 4,000 4,000
Development profit 1,000 1,000
Profit on cost 25% 25%
Profit on sales 20% 20%
Bank facility 2,750 2,750
Mezzanine finance                   750 0
Total bank and mezzanine funding 3,500 2,750
Equity 500 1,250
Mezzanine interest
and exit fee		 227 0
Net profit to developer 773 1,000
Developer’s annualised return on equity 103% 53%

As you can see, by using mezzanine finance the developer has been required to put in only £500,000 of his own money, compared to the £1.25m he would have had to put in without it. Not only has he almost doubled the return on his investment, (an IRR of 103% compared to an IRR of 53%), he has freed up £750,000 of equity to use on other projects.

2. It offers more control

Developers will often bring on board equity partners to help fund their schemes. This can lead to a host of issues not least of which is a lack of control. In our experience, equity partners nearly always want a say on how a development is run, and this can cause stress, conflict and even delay. In addition, equity investment can be expensive.

Many developers see mezzanine funding as “cheap” (and stress-free) equity. In most situations, more than 75% of the profit will accrue to the developer with the balance going towards the cost of the mezzanine finance.

3. Much of the cost is a charge on profits

The bulk of the cost of the mezzanine finance is payable as an exit fee on redemption of the loan. This means most of the cost of finance is a charge against profits earned rather than an additional working capital requirement.

4. It’s a highly flexible and simple source of funds

Mezzanine funding is by its very nature flexible. Every project we work on is different and we make sure we put in place a funding package that works for both the developer and the senior lender. For example, in some instances we will accept alternative security in place of the normal 10% cash commitment from the developer.

In addition, we will rely on the same valuation and quantity surveyor’s report prepared for the bank rather than our own advisors. This is not always the case with equity investors.

We also have an extremely rapid turnaround on decision making and the provision of funds. This ensures a smooth interaction between us, the bank and our respective solicitors (and, in fact, many of our clients are referred to us by banks).

5. It can get deals over the line

It would be wrong to suggest mezzanine finance is never used to get deals over the line. Bank lending to the property sector has reduced dramatically in recent years with mezzanine funding doing much to fill the lending gap. Many successful developers and profitable projects have made use of our mezzanine support to overcome the lending shortfall, but then continue to use our product on future deals.

6. Mezzanine lenders offer strategic assistance

Our business is to analyse each prospective project on the basis of its financial, marketing and construction viability to see if it fits within our lending criteria. This analysis includes the project timeframe, past experience of the developer and the availability of senior debt finance from a bank. This gives us huge knowledge and experience and we share this with our clients where it can help the success of a project.

To discuss using mezzanine finance on your next development project, call us now.

  • “I have used Argyll Property Partners for mezzanine funding on a number of developments and always find them highly professional and easy to deal with. I like the fact that they are so straightforward and make quick decisions. As they use their own money to lend they don’t need board approval and this makes the approval process very quick. I have no hesitation in recommending them for mezzanine funding.”
    Lee Clemson
    Director, Mantle Developments
  • “I think they are probably the best provider of mezzanine finance in the market. I am a client and a broker so I’ve dealt with them extensively with both hats on. Unlike some other lenders who do the same thing, Argyll fill you with confidence from the get go and offer support throughout the project. They are all very experienced, have a broad knowledge of the property market and respond to you quickly and professionally and with great efficiency. The relationship between them and my senior lender Close Brothers is seamless and always goes smoothly. I will use them again and will continue to recommended them to other developers.”
    Paul Smeeth
    Director, Charles James Developments Group
  • “I recently used Argyll Property Partners for mezzanine finance and found them highly flexible and good to deal with. They are very clued up about what is going on in the property market and gave me some valuable advice about the development. They have an existing relationship with my senior lender and this made things very easy. All the way through they did what they said they would do and delivered the funds quickly. I would recommend them.”
    Karen Seward
    Director, Modena Homes
  • “We found Argyll to be very quick and efficient. They gave their investment decision in short order and were easy to deal with. They understand the residential property market and had a good knowledge of the North Yorkshire market in which we operate. They were switched on to what we require – fast money and for the process to be simple when it comes to security packages and dealing with professional teams. Argyll were in fact introduced to us by our senior lender and they worked very well together as a team. We intend using Argyll again and have no hesitation in recommending them.”
    Nick Moody
    Newby
  • “Argyll understood our requirements very rapidly and came up with an almost immediate offer, which was highly impressive. As a result of the strong connection they have with the senior lenders and their speed and professionalism (and that of their lawyers), the whole lending process was seamless. The best recommendation I can give is that we will use them again and I would recommend them to other developers."
    Richard Hayward
    Director, Richard Hayward Properties