- 01 Jan
Why Real Estate Investors prefer Mezzanine Loans over other financing options
Mezzanine Loan is a financing method; it usually comes into play for big commercial real estate borrowings. A mezzanine loan is typically used to borrow more funds against any commercial property above any first mortgage on the property. Mezzanine Loan is quite a complex transaction, the following paragraph is an explanation of how it works.
The Mezzanine loan is a hybrid of debt and equity financing. This works like equity and the lender becomes the owner of the company (typically by getting shares in the entity) in case of default or non-payment from the borrower. However, in case of dissolution, the lender will get paid after the venture capital companies and other senior lenders. A mezzanine loan is typically awarded a very less due diligence as compared to traditional financing. Also, there is no collateral on the part of the borrower. But it is treated like equity on the borrowing company’s balance sheet.
Please note that these loans are not meant for residential property financing. As the funds are awarded from the borrowers by keeping in view the feasibility of the business property against which they are lending money. However, mezzanine financing is playing a very important role in commercial real estate financing and is preferred by borrowers as well as lenders when it comes to huge investments in commercial real estate projects. Coming paragraphs are a brief explanation of how it benefits both lenders and borrowing companies in big commercial real estate projects and how mezzanine loans make commercial real estate deals happen.
THERE ARE SO MANY PROS AND CONS OF MEZZANINE FINANCING. HOWEVER THIS FINANCING METHOD IS PREFERRED BY BORROWERS DUE TO FOLLOWING REASONS:
- The interest payments on debt are a tax-deductible expense, which saves a lot of money in taxes. As the borrowers in such transactions are not small companies but big business entities so they will surely like reducing their taxes.
- Lenders in mezzanine financing are usually very mature entities and go for long-term investments. Usually, they are willing to start a new one upon the maturity.
- There is no collateral required for mezzanine financing which makes it quite easier for borrowers. Even if they have property available for a mortgage, they can keep it and consider it for any other financing they may require in future.
- Mezzanine financing provides companies huge capital amount to start a new project, expand the existing business and even to acquire another business.
- With no doubt, the borrowers lose some independence upon getting mezzanine financing but this does not mean that they will lose control over the company operations or they will not be able to give directions. If the company grows and keeps repaying the debt. there will be no interference by the investor or lender and the borrowers will have same controls in the company.
Mezzanine financing not only have benefits for the borrowers. But also it has so many benefits for the investors as well. Following pros for the investors make them comfortable in lending huge amount of money in a riskier financing:
- With no doubt, without any collateral, it makes mezzanine financing quite risky for the investors. But by keeping in view the simple rule of business; higher risk comes with a higher reward, huge investors are more likely to invest in mezzanine financing than traditional financing.
- Interest rates are much higher in mezzanine financing which makes investors comfortable in investing in mezzanine financing.
- Mezzanine financing comes with ownership in the business for the investors, which is a great perk for the investors.
- In case of default, lender not only has right on the project for what they made the investment but also have the right to other assets of the borrowing company. But please note that the right of mezzanine lender over the company in any case of default or inability of the company to repay is always after the venture capital companies and other senior lenders.
- The repayment period of the mezzanine loan is even shorter than commercial mortgage; commercial mortgage comes with a shorter repayment period than a residential mortgage. Therefore getting higher interests in a shorter period is a perk for the investors in mezzanine financing.
- Mezzanine financing has not any standard terms and conditions, they are designed with the mutual consent of borrowers and lenders. And in this way it enables the lender to restrict borrowing company in all the areas of its operations for doing many things e.g. lender can restrict borrowing company to take any additional loans, refinance senior debt from traditional loans or create additional security interests in the assets etc. Also, the lender may require from the borrowing company to meet various financial ratios.
Hence, it is concluded that there are benefits as well as some unlikely conditions for both the lenders and borrowing companies. But mezzanine financing is a win-win deal for both of the parties in case huge real estate investments. Mezzanine financing is usually multi-tiered financing and in this way, it makes the deal feasible for all the parties involved. Huge investors usually do not like putting all their eggs in one basket and this makes lenders invest a bit more than half of the value of the transaction. In such a way they can invest in more projects to diversify the risk which makes any investor much comfortable.
1. Mezzanine financing is a financing method which comes with a complex transaction usually in commercial real estate investments. 2.It gives the lender right of ownership in the borrowing company. 3.It has higher interest rates and a very short period for repayment as compared to other financing methods. 4.There is no collateral required which is a big perk for borrowing company. This is the most preferred financing method for the lenders as well as borrowers when it comes to huge commercial real estate investments due to its features.