What is mezzanine financing and how is it changing the investment market?

Mezzanine financing in emerging markets

In developing financial markets, the concept of mezzanine financing is just beginning to gain popularity, while in Europe there is already a noticeable trend where one in four development projects receives funding specifically through mezzanine funds. Mezzanine financing refers to a specific type of loan provided by investors to facilitate the implementation of projects such as land development, construction of facilities, or expansion of rental property portfolios.

This type of financing can be seen as an intermediate category between traditional bank loans and direct investments, which is reflected in its name, derived from the Italian word "mezzanino," meaning "intermediate." Interestingly, the term used to refer to an extension with a balcony also has its roots in this word.

Structure of mezzanine financing

Mezzanine financing has clear terms, repayment conditions, and straightforward payment schemes. In some cases, the investor not only receives fixed interest on the loan but can also expect a share of the company's profits, making this method of investment even more attractive.

Key structures of mezzanine financing

• Mezzanine financing in the form of equity capital with additional asset collateral and guarantees from management companies.
• A project bridge loan for developers is a short-term loan provided until other sources of financing are secured.
• Acquisition of a stake in a company with unique classes of shares, option contracts, and stock purchase rights.

Advantages of mezzanine financing

Mezzanine financing is primarily interesting to those investors who seek to obtain passive income in foreign currency, want to minimize the complexities of managing commercial real estate, are looking for remote investments, or are willing to provide financial support for external projects.

Repayment of the mezzanine loan

As for the repayment of mezzanine loans, they occupy a secondary position in the payment queue, following bank loans but ahead of equity. This means that investors will only be able to claim the remaining profits of the company after all bank loans have been fully repaid.

Payment schemes for investors

• Regular and predetermined percentage payments.
• Deferred interest payments (pay in kind - PIK), which are made at the end of the specified term but accrue throughout the entire period.
• Payments that allow participation in the increase in the company's value can be organized through options and warrants, providing the opportunity to acquire 1-5% of the company's shares. However, this method is advisable to use only for experienced investors.

Expected investment return

Participants in this sector enjoy a number of significant advantages. The expected return on such investments is on average8-10% per annumIn currencies that significantly exceed the rental yield of real estate in Europe, potentially one and a half to two times higher. This opens up opportunities for generating sustainable passive income, making mezzanine financing a very attractive tool for conscious investing.

Introduction

Companies engaged in attracting financing manage projects comprehensively, from their development to final implementation. Modern technologies today allow investors to conduct remote operations, significantly expanding their opportunities. Mezzanine financing provides the chance to invest from any continent, using both local and foreign bank accounts. There is no need to register companies abroad or notify the tax authorities of the Russian Federation about the existence of foreign assets.

Advantages of mezzanine financing

Mezzanine investments provide companies with the opportunity to reduce costs and increase the profitability of their equity. By structuring their capital with a larger amount of debt, organizations can:

• Reduce the cost of capital (WACC);
• Increase the return on equity (ROE).

When standard bank financing is insufficient, mezzanine loans become indispensable in two situations:

• When raising equity capital is burdensome;
• When it's not enough.

Types of projects for mezzanine financing

There are two key areas where mezzanine financing is directed: development projects and leasing.

• Rental projectsThey are perfect for beginner investors with limited financial resources.
• Developer projectsrequire significant investments and in-depth knowledge in the field of development.

Minimum investment amounts

The minimum investment amounts for rental projects start at 25,000 euros, while the entry threshold for development projects is 500,000 euros. Using the raised funds, the company can create a portfolio of properties for commercial rental or management. This portfolio may include:

• Skyscrapers;
• Residential complexes;
• Supermarkets;
• Hotels.

When generating income, the organization pays investors a fixed percentage of the invested funds, while the remainder is directed to its profit.

Expansion of the project portfolio

In addition, with the help of raised capital, developers have the opportunity to expand their portfolio by constructing or developing plots. After the project is completed, the developer repays the bank debt, paying investors both interest and the principal amount of the loan.

Deadlines for exiting projects

The usual timeframe for exiting such projects is:

• From 6 to 8 years for development projects;
• From 2 to 4 years for rental projects.

It should be noted that payments can occur regularly, most often quarterly, but there is also a PIK (Payment-in-Kind) scheme, where interest payments are made only at the end of the period, and accruals are done once a year.

Essential knowledge for investors

Rental projects do not require investors to have prior knowledge of the market, whereas successful participation in development projects necessitates a good understanding of the processes in this field.

An example of a successful investment project

An example of a relatively successful investment project is investing in a residential real estate fund in Germany, where the minimum entry threshold is 25,000 euros, and the payback period ranges from 6 to 8 years with an expected return of 8-10 percent per annum. The invested funds are used to purchase and manage residential properties, which are then offered for long-term rental.

As of today, our management oversees approximately 18,000 residential properties, with total investments amounting to 1.6 billion euros. We are offering mezzanine financing for the development of a modern apartment building in Leipzig, with a minimum investment amount of 500,000 euros. The investment period is 1.5 years, with an expected return of 12% per annum.

Conclusion

In conclusion, I would like to emphasize that mezzanine financing, despite its relative novelty in emerging markets, is a powerful tool capable of transforming the landscape of investment opportunities. This unique type of capital not only allows investors to earn stable returns and participate in multimillion-dollar projects but also provides companies with the opportunity to increase their profitability without resorting to excessive debt burdens.

When I delve into the details of mezzanine financing, I am particularlymesmerizingIts flexibility and the possibility of remote investments. For many investors, especially beginners, this becomes the ideal solution — accessible, safe, and without the need to manage assets in another country. The strategic capitalization structure offered by mezzanine financing can significantly reduce financial risks while simultaneously increasing project efficiency, which is extremely important in today's market conditions.

Risks and opportunities

It is important to note that while mezzanine financing opens up a wide range of opportunities, it still carries a certain degree of risk, especially for those who choose development projects without adequate experience. However, with the right projects and a thorough understanding of key aspects such as payment structure and repayment timelines, investors can expect a quite attractive return.

Advantages of mezzanine financing:

• Stable incomefor investors.
• Flexibilityin the capital structure.
• The possibility of remote investments.
• Reduction of financial risks.

Prospects and development

In conclusion, mezzanine financing is becoming an increasingly relevant solution for both investors and companies looking to maximize their successes in the current economic environment. For me, as the author of this article, it is clear that this is just the beginning, and each year we will witness its growth and expansion on the global stage.