Back to basics: Mezzanine finance

Rightly or wrongly, many developers worship at the altar of leverage – their appetite to maximise return on equity dominates their approach to finance.

Conventional senior debt development finance was traditionally limited to around 50% GDV. In today’s market, of course, it is possible to secure finance up to 70% or even 75% of GDV as specialist providers tap into the capital markets’ ever-rising appetite for risk. This spiced up version of first charge finance is now characterised as stretch senior for obvious reasons.

An alternative to stretch senior is to split the financing into two layers of debt instead of one. The first layer – the senior – can be structured conservatively and to achieve the lowest possible cost is typically provided by a large bank. On top of this senior layer sits a strip of mezzanine debt from a specialist provider in a second charge, subordinated position.  

In isolation, mezzanine finance – or “mezz” – looks expensive, but when it is blended with a bigger chunk of cheap senior debt, the overall cost can be lower than a stretch senior deal can achieve. 

There is more work involved in assembling and managing a structured solution, so mezz tends to feature in larger transactions where the complexity can be justified. Smaller deals will still tend to opt for the simpler one-stop shop of stretch senior. 

Stretch senior debt is a bit like buying a pre-mixed gin and tonic. You get a pre-blended product with the low/no-risk layers subsidising the riskier end of the deal and it is sometimes difficult to work out the true cost of the individual layers because they are all packaged up together. Sometimes lenders are not clear themselves about the underlying architecture of their own pricing.

Mezzanine finance can help drive transparency and greater visibility of the way the pricing is structured and can provide you with the insight to optimise the formula of cost and leverage. So, think about mixing your own G&T – it may taste better.

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