The perfect storm driving developers to second-tier finance
A perfect storm of financial pressures on UK developers has sparked a spike in demand for mezzanine funding.
Typically, developers depend on a mix of bank or investor borrowing and their own capital to finance projects but mezzanine financing provides a second-tier loan behind the bank’s.
It is usually deployed to free up capital so that the developer can use it to invest in other projects rather than wait for the current development to complete and sell.
Not only does that allow the developer to snap up good opportunities when they arise but also to spread the risk, rather than have all the business’s cash tied up in one or two investments.
Sometimes mezzanine finance makes the difference in getting a project over the line rather than stalling due to insufficient funding.
Those are strong arguments in any market conditions, and in 25 years of specialising in mezzanine finance for residential property, we have seen many housebuilders using it effectively on multiple projects for those reasons.
In the past year, though, we have seen very significant increases in demand from existing and new clients as the industry grapples with a surge in cash strapping issues.
The first of these is rising costs, particularly for materials, that at best drain cashflow and can lead to investors asking awkward questions about the development’s financial viability.
Another supply side issue is pressure from suppliers for up front funding. That messes up cashflow forecasts based on longer payment terms and causes raised eyebrows at banks which dislike releasing funds for materials that aren’t yet on site.
Off-site payments like these are a challenge for developers. Many more sub-contractors and materials suppliers are demanding at least some of their payment up front than used to be the case.
That’s because they are clearly feeling the pinch, as we saw when the share price of builders’ merchant Travis Perkins tumbled in June following a lower-than-forecast profit warning for this year.
Essentially, developers come to us for liquidity. Because of the different proportions of land cost and build cost funded by senior debt lenders (banks and institutional investors), developers are left needing working capital to finance new projects or keep work in progress liquid through bridging loans.
That’s true at the best of times. Add to that the growing cost of materials and supply chain shortages, and the upshot is that developers need more cash than ever.
It is this that has translated into a growing need for mezzanine finance in the last year, even though the property development industry is currently less buoyant than it was prior to the rise in inflation and cost of borrowing.
That is not to say that we see the future as bleak. Far from it. Certainly, the housing market has yet to recover to its strongest levels.
But there are reasons to hope for a recovery.
Some commentators were critical of the March budget for failing to do more to stimulate new housebuilding, but as others pointed out, the new Chancellor succeeded in settling the market after the calamitous fallout from the infamous mini-Budget.
Meanwhile, in March, Reuters reported that Berkeley Homes were cautious about the near-term prospects for the market but said they would hit their profit forecast. More recently, in May, Barratt Homes were also on track to meet profit expectations, with the Evening Standard reporting that the housebuilder saw signs of recovery.
In our niche of the market, we see strong grounds for hope that things are moving in the right direction.
At Davon, we specialise in providing mezzanine finance ranging from £100,000 to £3 million up to 90% LTC. Our clients are experienced developers of residential schemes with planning consent.
We aim to give developers the freedom to minimise the amount of their capital that is tied up in any one project enabling them to invest in multiple projects at the same time.
In common with most mezzanine finance lenders, we typically provide up to 72% of the gross development value on a combined basis with the senior debt lender. Our loans are for up to 24 months with flexible interest rates on a non-compounded basis, taking a second charge security against the asset, backed by a formal agreement with the senior debt lender.
Residential development can be stressful even during heady market conditions. With the market facing additional pressures, from higher interest rates to nervous suppliers and investors, we’re proud to be helping to make new developments happen.
Freeing up capital for new developments, reducing risk and improving cashflow are all reasons why we have seen demand for mezzanine finance surge in the last 12 months.
Whatever the future market conditions may be, we expect mezzanine finance will maintain and build its place as a valuable tool for developers to bring projects forward and complete them successfully.