Mezzanine financing
Mezzanine financing is a layer of capital that sits between the ordinary bank loan and the equity in a property project. The name comes from the Italian word for a mezzanine floor. A mezzanine lender lends money that carries more risk than the bank's loan, but less risk than the equity, and in return requires an interest rate well above the bank loan, often 8% to 15%. The model is used when a project needs more capital than the bank will lend, but the owner does not want to put in all of the remainder as equity.
The position in the capital structure determines the risk. With pant (mortgage security) and priority, the bank comes first: it holds security in the property and is paid first if things go wrong. The mezzanine capital sits further back in the queue, with security in second priority or in the shares of the property company instead of in the building itself. The equity sits last and takes the first loss. Because the mezzanine lender takes more risk than the bank, the loan is priced higher, but it is still cheaper for the owner than raising the same amount as equity, which requires an even higher return.
For the owner, the point is that mezzanine capital lifts the loan-to-value ratio on the total project without diluting the equity as much. If a purchase of 100 million needs 70 in bank debt, 15 in mezzanine can mean the owner only has to put up 15 in equity instead of 30. This sharply increases the potential return on equity in good times, but it also amplifies the loss in bad times, because a larger share of the cash flow goes to servicing debt. Mezzanine loans often have a shorter term than the bank loan and are widely used in development and value-add projects, as an alternative or an addition to construction loans and bridge financing.
Mezzanine capital typically comes from specialist funds rather than ordinary banks, and the agreements usually contain strict loan covenants and sometimes a right to convert the loan into an ownership stake if the project defaults.
From Placepoint's dictionary: Mezzaninefinansiering
More information: Finanstilsynet: Næringseiendom, Store norske leksikon: gjeld
Norwegian: Mezzaninefinansiering.
Common questions
What is mezzanine financing?
It is a layer of capital between the bank loan and the equity in a property project. Mezzanine capital is more expensive than bank debt, but cheaper than equity, and is used when a project needs more capital than the bank will lend.
Where does mezzanine capital sit in the capital structure?
Between the bank and the equity. The bank holds first-priority pant (mortgage security) and is paid first. The mezzanine capital sits behind the bank, often with second-priority security or security in the shares of the property company. The equity takes the first loss.
Why do owners use mezzanine loans?
It lifts the loan-to-value ratio without requiring as much equity, so the return on equity increases. In return, the risk increases, because more of the cash flow goes to servicing debt.
What does mezzanine financing cost?
The interest rate is typically 8% to 15%, well above the bank loan, because the lender takes higher risk. The agreements often include strict covenants and sometimes a right to convert the loan into an ownership stake on default.