- Mezzanine finance is a unique hybrid of debt and equity finance
- Strong pre-sales allow off-the-plan developers to secure this type of financing
- Lower debt costs have also facilitated demand for mezzanine financing
Mezzanine financing is a unique hybrid of equity and debt financing that gives the lenders, in the case of default, the right to convert to an equity interest in the company.
Mezzanine loans don’t require payments during the term of the debt itself but rather at the end of the term. The main advantage of this is a company can improve its cash flow, helping it to pay off other debt first along with investing in the business.
Traditionally, this type of financing offers more generous returns but is riskier for both parties – owners are at the risk of losing equity and lenders risk losing their entire investment. In the case of bankruptcy, mezzanine lenders debt may not be fully recovered as senior debt holders get paid first.
According to Stamford Capital Joint Managing Director, Michael Hynes, savvy developers are using trading bank lenders and incorporating mezzanine finance into their development finance stack, due to strong sales demand for off-the-plan developments.
“Residential is back with a vengeance and particularly over the last six months, off-the-plan developers are able to show the strong pre-sales needed to secure mezzanine finance through the main trading banks.”
“Bank appetite for mezzanine hasn’t changed, yet over the last few years many developers struggled to meet pre-sales criteria in the wake of the GFC and stricter lending rules resulting from the Royal Commission. But that landscape is completely transforming with a surge in residential pre-sales, making mezzanine finance more attainable.”
Michael Hynes, Stamford Capital Joint Managing Director
Mr Hynes added that the surge in residential pre-sales is transforming this landscape. He believes this makes mezzanine finance more attainable, as the combination of trading bank senior and junior debt in a development finance stack remains more competitive than non-bank senior-only alternatives.
“Our modelling indicates the savings are around 15%-20% of your borrowing costs. We closed a $20 million capital stack recently using bank and mezzanine, which proved $250,000 cheaper than the alternative non-bank senior-only solution,”
Notably, the company has seen banks closing mezzanine loans over existing investment assets. Traditionally for their lower risk profile, banks have favoured pre-sold developments.
Mr Hynes expects this trend to continue in the post-pandemic world.
“Mezzanine on existing investment assets is a new trend, no doubt helped by lower debt costs post-COVID relieving ICR covenant pressure. These stacks are presenting as a cheaper cocktail relative to the non-bank senior only alternative.”