Joint venture, mezzanine and equity development finance

Development projects are often funded in layers. Senior debt is the main loan, secured by a first charge and repaid first. Mezzanine finance sits behind it, usually with a second charge. Equity, from the developer or a joint venture partner, takes the most risk and is repaid last. Each layer covers part of the total costs.

The layers together are called the capital stack. The more of the costs funded by debt, the less of the developer's own money is needed, but the higher the overall cost and risk. How senior development finance works is explained in the development finance section.

Mezzanine development finance is a loan that sits behind senior debt and covers part of the gap between the senior loan and the total costs. Because it is repaid after the senior lender, it carries more risk and is priced higher. The senior lender usually has to consent, and an intercreditor agreement sets out each lender's rights.

Mezzanine lenders look closely at the profit margin, because their repayment depends on the scheme making enough to clear both loans. Some charge a share of the profit as well as interest.

Stretch senior development finance is a single loan that covers more of the costs than a standard senior loan, avoiding a separate mezzanine lender. It is simpler to document but usually priced between senior and mezzanine levels. Cost overrun finance is extra funding to cover build costs that rise above the original budget during the project.

Lenders build a contingency into most development loans, typically as part of the cost plan. Where overruns exceed it, extra funding may come from the developer, the existing lender or a separate facility, each with its own conditions.

In a joint venture, a funding partner provides some or all of the money needed, including the developer's usual equity contribution, in return for a share of the profit. The developer contributes the site, the expertise or the planning gain. A joint venture can make a project possible where the developer lacks the capital for the deposit.

Joint ventures are set up through a shared company or a contract that sets out who funds what, who makes decisions and how profit is split. Legal advice is usually needed on the structure and tax treatment.

Each extra layer adds cost. Mezzanine and stretch senior loans are priced higher than senior debt, and equity partners take a share of the profit. The more layers there are, the more parties must agree before decisions are made. If the scheme underperforms, junior lenders and equity partners are repaid last and may lose money.

Comparing a simpler structure with a smaller loan against a layered one helps show the trade-off. Development finance brokers who arrange mezzanine and joint venture funding can compare the options on a specific scheme.