Mezzanine finance is a common method of investing into a property development project. ‘Mezzanine’ funding means it sits between two other forms of funding - in this case senior debt and equity (commonly provided by the developer), similar to how a mezzanine floor sits between two other floors. It is a secured debt product which pays a fixed rate of interest. Unlike equity which is linked to a profit share and can therefore fluctuate, loan interest is due despite potential market changes.
Order of Payment
On a typical development project returns are paid to debt and equity providers in the following order; senior debt (secured by a first charge) is the first to be repaid; next the mezzanine loan (including mezzanine loan interest); and then equity (developer & equity investors) are repaid their capital and any profits. In some cases, equity investors may also be repaid their capital and profits ahead of the developer’s capital and profits. It is common for the developer to be the last person to be repaid.
Interest can be applied to the loan at either a fixed rate or compounding and interest on a mezzanine loan is typically paid in one payment at the end of the investment term. Delays in a project could lead to an increase in the investment term, but interest will continue to be due for the duration of the investment term, meaning the total return will increase and the annualised return will be unaffected. In many cases a penalty rate will be applied to the loan so the total and annualised return for the investor may increase as a result of delays. The exact terms are specific to each project and agreement.
Mezzanine loans are typically secured by a second charge over the property, with the senior debt taking priority as the first charge holder. The mezzanine loan may also benefit from a personal guarantee from a developer. Again, the exact terms are specific to each project and agreement.
The mezzanine loan documents contain information about the terms and conditions associated with the loan. The documents also establishes the relationship between the layers of financing. There may be an opportunity to place the developer in default where the terms of the agreements have been breached. This means the developer can be asked to repay the loan and the interest accrued. However, there is no guarantee that the developer will have the ability to do so.
Homegrown is a crowdfunding platform allowing everyday investors the chance to back residential UK property developments by investing as little as £500. Homegrown uses both equity and mezzanine loan investments to fund property developments. If you want to find out more, you can sign up for updates or contact one of the team at firstname.lastname@example.org. As with any investment, as well as potential benefits, there can be risks too. Make sure you fully understand your investment before entering an agreement and seek financial advice if needed.