Case studies – in which mezz has been used as an alternative to stretched senior – show that sometimes achieving the last 5% or 10% of lending can prove pretty expensive if calculated on a marginal cost basis.
On some occasions, it can be beneficial for developers to add their own capital, which isn’t always possible, or to split the debt across two lenders using mezzanine finance.
We recently worked with a developer on an office-to-residential conversion in Manchester. The senior lender was able to offer the developer a £5m loan up to 60% loan-to-cost, at a rate of 6.5%, but the client wanted to raise an extra £3.7m, taking the loan to cost up to 90%.
We helped him to achieve this by providing a mezzanine loan at a rate of 18%. The effective total rate here worked out at 11.40%, which is lower than the developer could have hoped to achieve with stretched senior finance for this type of leverage.
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In this example, mezzanine finance accounts for a significant slice of the overall borrowing. On developments where a smaller proportion of mezz is required, the effective rate will obviously be lower.
As an example, assume that a scheme has a GDV of £11m and a developer who needs to raise 70%. Stretched senior lending at this leverage would probably cost between 10% and 12%. A senior lender might be able to offer a rate of 7.5%, but only able to lend up to 60% GDV (£6.6m). However, mezzanine finance could plug the gap, providing an extra £1.1m to take the total GDV to 70%.
The mezz slice of the loan might cost 18%, but the total effective rate of the borrowing would still be 9% – lower than the cost of stretch senior borrowing.
There are other considerations with mezzanine finance, of course, as more work and time is required in assembling and managing a structured solution, and this can involve significant legal costs. So mezz tends to feature in larger transactions where the complexity can be justified. In addition, structuring a successful transaction requires a good working relationship with the parties concerned, and a senior lender that is able to take a pragmatic stance regarding the deed of priority.
But for the right deal, mezzanine finance can be used to drive down the cost for developers who are stretching for extra capital and, as such, is an important tool for intermediaries to have in their armoury.