Mezzanine financing is a well-known concept, especially in acquisition situations and complex deals. As major banks have become more conservative in recent years, there is space for alternative financing methods. But what is mezzanine financing exactly, and how is it applied in the real estate sector? Our partner and credit specialist MSc. Art Nijhuis explains:
Mezzanine Financing: What Is It Exactly?
Mezzanine financing is a form of capital with a hybrid character, combining features of both debt and equity. The term ‘mezzanine’ means ‘intermediate floor’ or ‘entresol.’ Mezzanine financing is positioned between senior debt (traditional bank loans based on the first right of mortgage and the highest priority) and equity (without securities and with the lowest priority).
Mezzanine financiers bear a higher risk than senior creditors because their claims are subordinated to senior debt. Additionally, there may be limited or no securities, such as only a second right of mortgage, without immediate execution.
In exchange for the higher risk, mezzanine financiers request a higher interest rate. There is often a profit-sharing right or the possibility to convert into shares. This allows for potential benefits from an increase in the equity value.
Mezzanine financing is often attracted in large real estate transactions in combination with senior debt and equity financing to form a comprehensive capital structure. An important advantage of mezzanine financing is its flexibility in terms of structure and conditions. The loan can be specifically tailored to the complexity and phase of a real estate project, as well as the specific time horizon, risk profiles, and return expectations of the involved parties. This way, the potential return on investment for the entrepreneur is optimized (the so-called leverage).
Mezzanine Applications in the Real Estate Sector
How is mezzanine financing applied in the real estate sector?
- Development Projects
Mezzanine financing is most commonly applied to complex real estate development projects. Developers can attract mezzanine capital to bridge the gap between the senior loan from a traditional lender and the equity they invest themselves. It serves as an additional source of capital, limiting the need for equity. The remaining equity can then be used for alternative projects.
Mezzanine financing can also be used for the refinancing of existing loans on a real estate portfolio. If there are limited opportunities to attract additional senior debts to the portfolio, mezzanine financing can serve as an intermediate form of capital to increase the refinancing amount. This way, equity can be freed up for alternative investments.