Builder Mezzanine Loans

What are Builder Mezzanine Loans?

Mezzanine Finance is the broad financial term given to a certain kind of debt, which has the characteristics of both debt and equity. What basically happens in this kind of finance is that the lender of the debt gets an option to convert the debt into in equity in case of default or in case of late repayments. Generally their right to repayment comes after the senior lenders like banks and venture capital companies. Since this type of finance is provided at a very short time and without any collateral the rates of interest charged on it are high in the range of 20 - 30%.

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This type of debt is good for the borrowers because they can get it quickly and also as it is treated like equity in the books of accounts it makes it easier for them to get further debt.

Builder Mezzanine Loans

The mezzanine lending industry is just about 8 years old and before that this was something that was unheard of in the builder community. However, this has gained currency rapidly and is estimated to be a $14 billion market. The need for Builder Mezzanine Loans was created when a few years back there was a collapse in the debt market and lenders started to ask for part of the profits in the finished buildings. This sometime went as high as 50% and created a huge gap for money, which the builders needed to complete their buildings, as the loans from the senior partners were not enough to execute the entire project. This led to the emergence of Builder Mezzanine Loans for the builders and although they charged an interest rate which was higher than what was prevailing in the senior debt market they still presented with better terms because they were not interested in taking a part of the profits.

The repayment tenures are also shorter when the builder goes in for mezzanine finance. This is because unlike other creditors the mezzanine finance does not hold any collateral and thus has a greater chance of loss through default. One of the major causes of losses to builders is that they are slow in marketing and selling the property once it is constructed and therefore the shorter repayment tenures which are hoped to put extra pressure on the builders to sell off their property quickly and consequently repay the loan fast as well.

Benefits of Builder Mezzanine Loans

One of the critical benefits of mezzanine finance to builders is that fills up the gap in the entire financial requirement which the senior lenders are not willing to complete. Another benefit is that it boosts their return on equity and also the rates are getting competitive in this field. About a couple of years ago this was still an area which had a relatively few number of players but now a large number of private players, insurance companies, conduit lenders etc. What this means is that the market place is getting increasingly competitive and because of that the interest rates have come crashing down making it even more attractive to builders. What is also helping the builders is the fact that the default rate in mezzanine finance is generally quite low making the price or interest rate further drop.

What are the Financiers looking for?

However, let the growing market and increasing number of willing lenders not lead you to believe that financiers are queuing up to give money to everyone. Every builder and project has to go through some evaluation criterion which are as follows:

Location is the key and projects should be located in strong markets

There should be significant cash equity contribution by the borrower to show their seriousness

Healthy profitability

Experience of the developers in the kind of projects that they are looking for finance in

Loans in the $1 to $10 million range, but different lenders will have different range

Annual returns of approximately 30%

Terms of 6 to 30 months

Well Defined exit strategy for the lenders to monitor whether everything is going as planned.

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