Nils Baker, Partner at mezzanine lender Ultimate Capital, explains more about how this type of finance can not only facilitate a development but can also help to maximise profits…

The lending market property professionals have to operate in is very different from that of the past. As a developer you can hark back to the days of old or, alternatively, you can take stock, look around at what’s available and carry on.

Though many developers may bemoan the end of the good old days of incredibly generous lending, one thing is sure, they are 100 per cent over. Conservative LTVs, strict valuations and Basel III are here to stay for the foreseeable future. 

So what does today’s developer do? Do they marshal their resources and put them all into one deal or do they look to the funding market for support that allows them to trade at a meaningful level, potentially over more than one project?

As it stands there are two main options to the developer who requires additional cash:

Assuming the developer chooses option two; the requirements of the mezzanine funder shouldn’t come as a shock if they have dealt with a bank in the last three years. The funder will probably require a personal guarantee and, if you want to really push the LTV, they may require additional security. But in terms of information it should all be pretty standard. 

What may take some getting used to is the rate; it will be higher, typically 2-3 per cent a month. However, the question that they should really be asking is: “How much money can I make using those funds?” 

Let’s take a look at a simple example…

Mr. Smith wants to build a house. It will take a

to build and sell. The GDV is £1,250,000.  It will cost him £500,000 to build including fees and the site costs £500,000.  Mr. Smith will need £1,000,000 for the development, leaving a gross profit of £250,000 - a nice little deal.

Mr. Smith’s bank will lend him 50 per cent of the purchase and 100 per cent of the build. He still needs to find £250,000. He only has £125,000 of his own cash so will need to borrow a further £125,000 for the project.

If he borrows £125,000 on a second charge mezzanine basis at a rate of 2.5 per month, he will be paying about £37,500 for the loan. This means he keeps 85 per cent of the profit (and is making about 170 per cent on his cash), a far better deal than if he got an equity partner.

So why don’t more people choose to use mezzanine finance?

I think partly it comes down to a lack of understanding from brokers about what is both available and achievable, and also a reluctance from developers to look beyond headline interest rate figures and see how much more money it allows them to make.  

But which mezzanine funder should be used?

Other than the obvious points to check, such as whether the funder actually has money to lend (many fund raise on a deal by deal basis), it is always worth checking if they are happy to sit behind your first charge funder. Some first charge lenders have issues with mezzanine lenders: some will allow their borrowers to use them, others won’t. 

The next issue to consider is the agreement between the mezzanine funder and the first charge lender (this inter-creditor document is known as a Deed of Priority). It is vital that the mezzanine funder is realistic and flexible when it comes to this as without agreement the deal will stall. 

The partners at Ultimate Capital come from a development background and we realise that some projects need extra help to get over the line. We do not charge any arrangement fees or exit fees, and where possible will use existing valuations and professional reports. In many instances, once drawdown occurs legal fees can be added to the loan and the broker can set their fee (within reason!) and this, too, can be added to the loan.