Mezzanine Finance

Hello, and this time on the Bridging Finance podcast, we have Scott West joining us from Proper Ties to talk all about mezzanine finance. It's great to chat with you, Scott. How's it all going? Yes, it's going well, thank you. Like we said, everyone, the sun's coming out now, so it's easier. More projects on the go, more clients than projects, so yeah, looking forward to it. Yeah, that's good news. We are recording this episode in May 2024, so we're getting a glimpse of summer, aren't we, at the moment? Only for a few days, I know. And if you're listening to this during winter time, then it's probably going to sound strange. Okay, so we've got a list of frequently Googled questions here. So just first of all, then, and for the listeners' benefit, what is mezzanine

financing? So mezzanine finance, mezzanine finances, we kind of tend to refer to it, comes generally in two different types. You've got mezzanine debt and you've got debt to equity. Most of the time when we're talking about mezzanine finance is the former mezzanine debt, so I'll answer most of the questions today, probably around that, because it's far more common. But it's typically used to, a bit like a bridging loan, cover the gap between where a product is and what it needs to get finished. So if you part me through a development, for whatever reason, the project's ever running in costs, and there's a shortfall, a mezzanine finance lender will come in and cover that gap between where you are and giving the

project finished. Right. Okay, there we go. So a great definition there. And with all that in mind, then, what are the advantages and disadvantages of mezzanine finance or mezz finance? So one advantage is that it sits behind your current primary lender. So you don't need to refinance entirely. You can leave the existing first-charge debt where it is, which is always useful because typically that would be cheaper anyway. So it sits behind that, so you can get the additional funding out without having to give away any equity to maybe a joint venture partner. So those are kind of the advantages. But the disadvantages are that it's typically a higher rate because the lender's in a higher risk position. Obviously, being a second-charge lender, they have their

legal charges second, secondary to the primary lender. So in the event that they went really wrong and they had to repossess, your primary lender gets first dips, all of their debts repaid first, and the secondary lender gets theirs last. So in the event that the property or the project sells for much lower than expected because it's not finished, that second lender, the mezz lender, is at higher risk of not getting all their money back. So their rates are higher. There's a slightly higher setup cost. And obviously, because of that, it can start to eat into the profit margins that you initially thought you were going to get when the project started. Right. Okay. There we go. So hopefully that's clear there.

Now, the next question here asks, how are debt mezzanine loans structured? Very similar to the development loan that you would have already had in place, which is a primary lender, hence we're looking at the mezzanine finance. They're very, very similar in structure to a bridging loan or second charge bridge anyway. They will sit behind your existing lender. They will roll up or retain their interest. There's nothing to service and they'll be guaranteed. And obviously, the quicker you repay that debt, the less interest or power next. So you get the rebate on that at the end as well. So very, very similar to the bridging products. So if you're familiar with those, there's a copy paste of that in essence.

Okay. Brilliant. Now, you've touched on this really already. Are bridging loans and mezzanine loans the same? Yes and no. Yeah. I've kind of half touched it already, I guess. They're very different products with usually very different lenders and risk profiles. But from the client's perspective, they tend to look very similar. So from our side as the brokers, we have a different lender choice. There's a different risk profile. We have to mitigate certain requirements for lender in a different way because obviously the project is half built versus with a bridging loan, you typically tend to have an existing finished asset that maybe you're doing refab work to, but it's the finished product. The mezzanine finance, you're usually partway through a

build somewhere. So they're different from our side. From the client looking in, they end up with a very similar result. It will end up being a second charge like a bridge. It retains the interest like a bridge and they get their money out. So for them, it will feel very, very similar, but they are two different things. Right. Okay. So clearly explained there. Now, moving on, what is the difference between senior and mezzanine debt? Senior debt is just the jargon that most of us tend to use. It is just your first charged lender. So it is the lender that came in first to give you the primary debt for that development. So we don't know why we've tend to threaten the senior, but that's just the way we do it. So that'll be your

first charged lender. He would have lent you the money for the build and they should have done all the affordability calculations and all the build cost calculations with the upfront. So that senior lender should have had, should have lent you enough money to complete the build in the first place. And the mezzanine debt just comes in, usually because there's a change of material costs as we saw during COVID or there is an incident on the site that means that additional works are required. You know, if something falls down, there's a fault that needs to be redone, something needs to be re-carded. I don't know what it might be. An event on site that needs more work than expected. Or if simply you kind of start to attack on things. People tend to get emotionally

involved and start thinking, well, I'll just add a pool and I'll just add an extra pile and I'll just add two more bedrooms and think the project gets larger and larger and the debt doesn't cover that. So the mezzanine finance just covers those bits. Okay. So that all makes sense there. Now we probably covered this a little bit when we were talking about the advantages and disadvantages, but is mezzanine financing risky? It's not risky inherently because there is an affordability-based calculation that the lenders will do. They will only have a certain loan to value that they'll go to. And that does depend on the lender, it does depend on the loan size and the project. So that will vary depending on your circumstances. But

it will go up to that loan to value, it will retain the interest. So there's no inherent risk to the client because the interest rolls up. There's no affordability to calculate necessarily. One potential risk is if for whatever reason that the initial senior debt wasn't sufficient, if that problem persists. So in the like I explained previously, if for whatever reason, it's expanding on the project and continues to do so above and beyond what the finance they've got from the mezzanine lender, the project would, you know, you run out of money again. So it's not the finance itself is a risky, it's just trying to work out why the client ran out of money in the first place and basically getting that risk, I guess.

Right. Okay. So let's move on again then. How much will a mezzanine finance provider let me borrow? It does depend on the size of the scheme. What it is you're building is commercial residential, where it is, the value, the GDV, your particular credit profile as we cover with bridging, you know, better your credit profile, the better the lender rates will give you a similar kind of process here. I would say typically you can get up to 70, sometimes 75% on some of those. That's loan to GDV. So we should be able to cover most of the costs that most people need. If you're pushing your loan to value beyond that, we need to look at the profit margins and your projects going forward as well. Okay, there we go. And then that leads

us on to the next question. Can I use mezzanine finance for residential development? Yes. You can use it for any sort of development. I mean, typically you wouldn't find it being used on very small projects. People who are building either a house in their garden, you know, people have very large gardens, they carve them off, get planning. You probably wouldn't find it applicable there very much for one or two properties, but if you're building sites with four, five, six houses or much larger projects, it might become more applicable for those previously discussed reasons that you might go over your budget. Okay. So that answers that one there. So the next question here asks, how long does it take to secure mezzanine finance or financing?

Pretty quick. Again, these short term products like bridging all tend to fall within a similar sort of timescale. So it can be arranged as quickly as

7 to 14 days, 1 to 2 weeks. Typically, I would say we want to be aiming for four weeks, really just to make sure everybody's on side. We've got time that the valuation is completed, legal is completed suitably. We don't want to rush things too much, but in the event of emergencies, it can be done much quicker. Okay. There we go. So again, that answers that one there. Now we have another question here that asks, what type of security do I need for mezzanine financing? I would hope that you have some security at this point. The development money has probably been built somewhere, but either project doesn't need to be at any particular stage for mezzanine finance, but obviously the state of the project, the state of your security will

determine how much money you'll get from mezzanine lender. If your project is most of the way finished, it's the roof's on, it's almost watertight. It's just the last fixtures and fittings and electricals, plumbing and some things that need to go in. Your mezzanine finance lender is going to have a much better time getting on board with that risk level because it's most of the way there. It's not a lot to finish. Your debt requirements are going to be quite small. If your project is really, really early stages and you've already blown through all of the development money, your senior debt, it's going to be very hard to convince a mezzanine lender to lend you the rest of the money to finish. While there isn't a specific security type required, we do need to kind of

demonstrate that there is a plausibility to where we are with the project and a plausibility to finish the project, I guess would be a better way of saying it. But it can be residential or commercial if you're thinking of that sort of question. Right. Okay. So something to bear in mind there. And just lastly, really, you've demonstrated this already, Scott, but how can a broker help here? Have you got anything else you'd like to add? Yeah, I guess pretty much the last 10 minutes of conversation will cover most of why a broker is useful because it's not a straightforward finance. It's not like going to your high street lender and saying, can I have any mortgage, please? And just switching products and where it might be.

This presentation of a case is very important. As I said, so if the project is at a certain stage and you've got enough money for whatever reason, how you present that to a lender makes a big difference to the lender's attitude to taking that on. How it gets to the credit, needs to be credit-proofed always. So the broker relationships, the presentation of the case, make a big difference. Broker relationships can sometimes negotiate rates, costs, other parts for you, and obviously will help manage the case through. Yes. There we go. Time saving there. Thank you for that, Scott. Hopefully we've helped a few people out on the episode, and I'm sure we'll speak to you on the podcast again soon.