Mezzanine financing: what is it and how does it work?

What is mezzanine financing?

Mezzanine financing is a specific category of lending that is ideal for those in need of additional funds beyond a traditional bank loan. This financing tool, which sits in the middle ground between developers' equity and bank loans, offers unique opportunities for developers in their quest to increase their financial resources.

Steps in the financing process

At the initial stage, the developer turns to a financial institution, which often finances up to 70% of the total project costs. However, if there is a need for even more financing, the developer can use a mezzanine loan. This type of loan requires a second lien on the asset, which implies that it is repaid only after the debts on the main loan have been repaid.

Advantages of mezzanine financing

One of the distinctive features of mezzanine financing is that principal and interest are most often repaid only at the completion of the project work. This approach allows to significantly reduce the financial burden at the stage of realization of the conceived project.

Bridging finance

There are other ways to raise capital, such as bridge financing, which is often used for short-term needs. In this case, the developer proceeds to find investors who get first priority for the collateral assets. Bridging financing is usually focused on the initial stages of a project, such as:

• Land Purchase;
• Start of construction works;

It can then be refinanced through a bank. This mechanism is very common, especially in projects with a lead time of 9 to 12 months. Often banks are not ready to provide short-term loans without lengthy approval procedures, which makes bridge financing relevant.

Investment prospects

Many investors in the Russian market believe that the cost of raising foreign loans is low, sometimes as low as 2% per annum. However, the reality may turn out to be different. In the UK, interest rates on construction loans range from 5-10%, and depend on a number of factors, including:

• Reputation of the builder;
• The size of his company.

This implies that rates on mezzanine loans, which carry a greater degree of risk, are often even higher.

Opportunities for private investors

Private investors see mezzanine finance as a tempting opportunity for some financial winnings. The minimum investment threshold can be relatively low - starting at £50,000 in the UK. Projects managed by such investors typically promise returns in excess of 10% per annum, making this type of finance attractive to those wishing to make money from the construction sector. These conditions create a variety of opportunities for interaction between developers and investors, which in turn contributes to the development and successful implementation of long-term construction projects in the current economic environment.

Mezzanine loans as a short-term investment tool

Mezzanine loans are becoming increasingly attractive to investment players who prefer short-term investment options that expect a return within one or two years. In today's realities, buying real estate may not always be the best option, and the stock market often does not provide long-term strategies unless you consider active trading as an income opportunity.

Advantages of mezzanine financing

With mezzanine financing, investors can count on a stable income and a clearly defined exit date from the investment project. This makes it possible to plan their investments in more detail. This approach is popular in the European investment community, and many see it as a tempting income opportunity.

Example of a successful project

A striking example of the use of mezzanine financing is a project to renovate a wine bar and convert it into an apartment building. To realize this idea, a mezzanine loan was raised with aan annual interest rate of 12%for a period of 8 to 12 months. In addition, the investor has the opportunity to participate in the distribution of profits exceeding the established percentage.

Investment opportunities in the global market

Today, one can find a lot of news about the global real estate market and investment opportunities in popular Telegram channels. The question often arises as to which projects are actively attracting borrowed funds from various sources, including private investors and investment funds.

Developers' approach to raising funds

When developers plan to raise more than 10 million pounds, they usually do not approach private investors because of the high participation threshold. The market leaders in providing significant mezzanine loans are the investment funds present in large numbers these days. Private investors are usually willing to invest sums in the region of 3 million pounds; however, if someone has the ability to invest just that amount, they can undertake the project on their own.

Opportunities for small investors

Individuals with between 50,000 and 400,000 pounds of capital can attract interest from projects that need to raise amounts between one and three million dollars. Developers often set up a loan structure in advance to attract collective investment and make it more affordable.

Loan structuring process

The process of structuring a loan is not complicated. A qualified lawyer is able to prepare all the necessary documents and execute a single agreement for a group of investors, which helps to create comfortable conditions for participation in the project.

Specific project examples

As an example, we can mention the construction of a complex for industrial facilities where the mezzanine credit amounted to20% p.a.with a 12-month term. The budget for such a project financed with a mezzanine loan in the range of one to three million dollars ranged from $8 million to $15 million. Typically, such projects involve smaller properties, such as residential buildings with a few dozen apartments or office complexes.

A project in the North West of England

There is now a project in the North West of England to finance a small residential home. Both senior and mezzanine loans can be used for such projects; in the case of the latter option, a bank will also be involved. It is up to the investor to choose whether or not to bank the developer, depending on the level of capital protection desired.

Conclusion

It is noteworthy that investors always have a choice, and this aspect is relevant not only for the UK, but also for other countries around the world.

Similar facilities in Germany

We have similar facilities available in Germany. Some of them use combined approaches, where the investor provides a loan and, at the same time, receives a share of the net profit of the project. As a result, these projects generate a total return close to the15% per yearand denominated in euros.

Search for private investors by developers

But how do developers find private investors? They usually research in advance the financial opportunities that may be available and build their offers around that. In order to attract private investors, they often need the help of experts like us, as they haveSavillshas a solid reputation in the industrial market.

Specifics of developers' work

Developers do not interact directly with private investors due to the nature of their work. It is more convenient for them to work through agencies that already have clients interested in such investment initiatives. For example, one of the developers with whom we cooperate has previously received mezzanine loans from wealthy clients who were willing to invest amounts from1 to 2 million pounds. However, as time went on, contacts dried up and new projects continued to emerge.

Adaptation of the loan structure

It is important to note that the number of people with capital in the50,000 poundsmore than those with capital funds reaching one million. Therefore, the developer changed the financial structure of loans to attract smaller investors.

The role of the investment adviser

At the other company, the partnership with us is managed by an experienced investment advisor who has30-year experiencein the field. He has extensive connections in the construction industry, and when a developer needs financing, they contact him and he then refers requests to us.

Diversity of interaction pathways

Thus, there are different ways in which development projects reach us and onwards to private investors from Russia. For example, one of the projects involves the renovation of an old commercial building into office space. In this case, funds from investors were raised with an offer of a return on investment10% per yearplus50% of net incomeproject. The illustrations were prepared by the Savills team.

Investor interests

What role does an investment adviser play? Savills' Russian office represents the interests of investors. Our reputation and future successes depend on how well we do this work. We are constantly looking for reliable developers, carefully checking their professionalism and analyzing financial models to accurately understand specific proposals.

The process of working with projects

If the project meets our criteria, we pass it on to investors.

Assortment of investors

Savills works with a diverse range of clients including major players such as:

• firms
• pension funds
• ultra-high-net-worth individuals with wealth in excess of30 million dollars

However, within this product, we are primarily focused onprivate investorswith capital from50,000 to several million. This allows us to find optimal conditions for all parties and contribute to a more efficient development of the investment market.

In fact, investors with limited funds are more readily available for search and attraction. They have the opportunity to familiarize themselves with the peculiarities of the system and, being satisfied with the results obtained, will more quickly decide to expand their investments, and can also recommend this experience to their acquaintances and friends.

The funds collected from program participants are directly allocated to the developer for a specific project. When the required amount is accumulated in the account, the incoming small tranches are combined into a single sum. The speed of raising capital depends largely on the specifics of a particular project. The most favorable investment offers usually allow raising the necessary funds in two or three weeks, while in case of a high entry threshold or unattractive conditions the process may take up to two months.

Consulting services and arrangements

The investor signs a consulting and project selection agreement that also includes administrative support. In some situations, projects are structured so that the client pays no fee at all and our income comes from the developer for the borrowed funds.

Degree of capital protection in the project

The degree of capital protection in a project is largely determined by the availability of collateral. This applies both to the net income and assets of the company in the case of corporate collateral and to the valuation of collateral provided by an individual when it comes to personal guarantees.

Interest rates in the range of 10% to 12% per annum can be considered as normal for this area. There are also opportunities for second lien mezzanine loans where potential returns can range from 17% to 19% per annum, but the associated risks need to be considered.

Understanding the risks

When deciding to invest in such strategies, investors need to understand the risks they are simultaneously assuming, including the likelihood of bankruptcy and its associated consequences.

For example, high yields of up to 17% may be associated with serious risks. First of all, these risks are of a market nature. If a borrower defaults on its obligations, it may declare bankruptcy, resulting in the need to sell off its assets in order to repay creditors. In this context, it is crucial to assess whether the assets are sufficient to cover the full amount of the loan.

Main threats

The main threats include a sharp drop in the market value of real estate, which can create a situation where repayment of principal and interest becomes impossible. If the project has no additional corporate or personal guarantees, the investor faces a real threat of losing the invested funds.

Specific example

Let's look at it in practice. Suppose there is a development project using developer's funds, a mezzanine loan and a loan from a bank. The probability of selling the project with a profitability of 20% has been requested.

In order for an investor to start losing money on a mezzanine loan, it is necessary that:

• the expected gains were not realized;
• the developer's equity capital turned out to be unprofitable.

This is where financial security lies. It is important to analyze the size of this financial cushion, what profit expectations have been set, how much money the developer has invested and by how much the value of the objects must fall for the investor to start incurring losses. We carry out such calculations, and the client is able to determine for himself whether he is ready to take the risk.

Risks for investors

In addition, according to Savills' research, in general, the risks for investors who receive secured loans do not exceed the risks arising from a conventional real estate purchase. This is especially true if the loan is secured by first lien and contains corporate guarantees.

The probability of a 25% drop in market price is considered quite low, while a 50% drop seems almost impossible.

Tax aspect for Russian investors

With regard to the tax aspect for Russian investors, the legislative regulations and the calculation of personal income tax are important in the financial strategy. For example, if a resident of the Russian Federation acquires new real estate or lots in the UK, he/she has the opportunity to rent them out by registering as self-employed or individual entrepreneur, paying 6% tax.

In the end, the profitability of such investments may be higher than in case of using borrowed funds. Thus, knowledge of tax nuances can significantly affect the success of an investment strategy.

Introduction to Real Estate Investing

Investing in real estate becomes profitable not only by generating rental income, but also by increasing the value of the property itself. When it comes to secured loans, it is important to keep in mind that income from such investments is subject to special tax rules.

Taxes on investment income

According to current legislation, if you borrow in foreign countries, it is necessary to return the funds to the territory of Russia. Interestingly, in the UK you are not obliged to pay tax on interest that comes from the developer, whereas in the Russian Federation it is necessary to paypersonal income tax(PIT), which ranges from 13 to 15%.

Investment example

Let's imagine a situation: you lent 50 thousand pounds sterling to a British developer. A year later, the amount of the refund will be 55 thousand pounds. On the additional 5 thousand pounds you will have to pay tax, which will vary from 650 to 750 pounds.

For most Russians who do not hold government posts, such financial investments have no restrictions. All financial transactions take place under strict control of currency legislation.

Experience of our company

Our company is actively engaged inmezzanine financingand so far has not encountered any problems in this area. On the UK side, all the processes are also quite transparent and simple.

• The funds are transferred directly to the account of the company that implements the project.
• KYC (know your customer) verification depends on the builder.
• Usually, the investor is required to have a passport, a mailing address and proof of funds, which can be done through bank statements.

What is important for investors to know

The main thing I want to convey to Russian investors is that obtaining loans should not cause you any apprehension. There are clear and understandable rules, as well as specific schemes for partnering with developers who are interested in raising funds from private investors. Market rates on such financial instruments are quite acceptable and should not be underestimated.

Prospects for mezzanine and bridge financing

Mezzanineandbridge financingopens up new perspectives for investors who want to place their capital for short periods of time and do not have a rigid plan. If your goal is simply to beat inflation, we recommend looking at stable loans backed by first lien and additional guarantees.

Those who are willing to take risks should consider more aggressive offers that can maximize returns. In this way, you can avoid mistakes and failures by choosing the right approach and strategy.

Having reliable information and experienced partners will help to greatly expand your financial opportunities and your investment horizons.

Mezzanine and bridge loans

Are you interested in mezzanine or bridge loans? Savills' team of professionals is ready to offer you expertise and support on these financial instruments. Contact us and we will help you understand the complexities and nuances of these services!

Credit information

If you are interested in learning more about mezzanine loans or bridge lending, our experts have the knowledge and experience to help you make an informed choice. These instruments can be a useful asset in your financial portfolio, opening up new horizons for business and investment.

• We will provide information on the important features of these loans, as well as review their pros and cons.
• Mezzanine loans are often used to finance projects where not only start-up capital is needed, but also additional resources to complete construction or other investment activities.
• They act as a link between equity and classic loans.
• Bridging loans are ideal for short-term financial needs.
• Their main purpose is to be able to bridge temporary gaps in funding, which is especially relevant in real estate transactions or situations where quick funding is needed.

Customer support

Savills customer service team is always available to provide you with information to answer your queries. To request a consultation, please complete the contact form with your name, email address and phone number. Our team will contact you shortly to discuss your query in more detail.

Importance of financial instruments

Don't miss your chance to access valuable insights into financial products that can make a big difference to your finances. Whether you are an investor, a businessman or simply interested in finance, we have quality recommendations for you.

Many people don't realize how significant a transformation can occur with the right recourse to borrowed funds.Bridging and mezzanine loans have the potential to be the very tool that will give you the flexibility and opportunities to expand your business.

Following financial trends

Follow the latest financial trends with Savills. Our experts are ready to share the latest market data so you can make informed decisions based on factual analysis.

A strategic approach to finance

With us, you will not only receive advice, but you will also be able to develop a strategic plan for obtaining and utilizing borrowed funds. We recognize the importance for businesses to adapt to changing market conditions.

Contact with professionals

Call or leave your contact information - we are always ready to provide you with the most comprehensive information. Work with professionals to get up-to-date information on new opportunities the first time.

Financial tools such as mezzanine and bridge loans can be your trusted companion in the financial world, offering opportunities that are hard to overestimate.

Conclusion

Together we can make significant progress and realize all of your dreams. Don't hesitate to contact us for advice - we are happy to help you at every stage of your financial journey.

Conclusion

In conclusion, I would like to emphasize the importance of mezzanine financing for the modern real estate market. This tool provides developers with the flexibility to manage their capital investments and raise the necessary amounts to successfully complete projects. Mezzanine loans are becoming an important link between traditional bank lending and equity, allowing developers to close financing gaps and minimize their own investments.

I call attention to the fact thatinvestorsThose that include mezzanine financing in their strategy can generate significant returns. This attracts private investors who are looking for more profitable ways to invest than classic bank deposits or the stock market. Despite the possible risks, mezzanine loans can offer a fixed rate of return and a defined exit period, which is attractive to many investors.

Key points

• Mezzanine financing is a flexible tool for developers.
• Allows funding gaps to be closed.
• Investors receive a fixed return.
• There are risks that need to be considered.

Nevertheless, as I mentioned earlier, it should be taken into account that mezzanine financing is not suitable for all projects. Its use must be justified by strong economic arguments and a well-designed development strategy.InvestorsIt is important to recognize the risks and understand the specifics of each particular project before making financial decisions.

Prospects for mezzanine financing

So, mezzanine financing is certainly an interesting and promising tool in the arsenal of developers and investors. It is important to be aware of the trends and peculiarities of this type of loans, as well as to constantly analyze the market to find the best investment opportunities. I hope this information will help you better understand the potential of mezzanine financing and its role in today's investment world.