How Mezzanine Financing Fit Real Estate Financing Gap?

Investing in large commercial real estate development projects requires a lot of money. The increase in financial regulations and loan restrictions in the aftermath of the 2008 global financial crises has created a gap between the needs of real estate investors and the offerings of the traditional financial products. One funding source that has emerged to fill this gap is mezzanine financing.

How Mezzanine Financing Fit Real Estate Financing Gap

Before selecting any source for commercial property development financing, you must evaluate both the pros and cons. Here we will take a look at mezzanine financing and shed light on both the benefits and risks so that you can make an informed decision.

Mezzanine Financing: An Overview

Mezzanine financing is a catch-all term for a category of non-senior mortgage debt and equity. The term is a hybrid financing source that contains elements of both debt and equity. The financing option shares characteristics of the following types of investment instruments.

  • Preferred equity
  • Second mortgage or Junior debt
  • Participating debt
  • Convertible debt

Mezzanine financing is generally used for financing real estate investment projects. They can be used for funding large real estate projects, as well as for strategic initiatives such as entering into a joint venture, purchasing a firm, finical restructuring of existing debt, and making payments to equity holders.

Pros of Mezzanine Debts

Mezzanine financing allows borrowers who do not fulfil the strict requirements of traditional banks to fund large commercial projects. The financing optionby and others involves no collaterals. Lenders focus on the cash flow instead of collateral assets. So, long a company has enough cash to pay back the amount owed, there will be no difficulty in securing the funds.

Another benefit of mezzanine debts is that it’s a cheaper option as compared to raising funds through equity. You don’t have to give ownership of the project to receive the required funds. As a result, you will have more retained profits when the project gets off the ground that you can use to fund growth.

Lastly, mezzanine capital has a long maturity of five years or more. You don’t need to repay the principal amount soon after borrowing. The financing option is not used as a bridge loan to fill any short-term financing gap. You can repay the loan once the commercial project starts generating profit.

Cons of Mezzanine Debts

Being a junior debt means that mezzanine financing is not collateralized. In other words, the funding option is not legally secured by associated cash flows or any physical property. As a result, it is a costly source of finance as compared to secured mortgage debt.

Also, mezzanine debts may involve warrants. The warrants may be attached by the lender to reduce the risk attached to a particular commercial project. This may result in increased cost of the debt.

Mezzanine loans are not for everyone. You should look at both pros and cons to fund commercial real estate development projects. Also, you should investigate alternative financing sources such as property syndicate to fund your commercial property development project.

Posted in: Real Estate