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When looking to expand your business, one investment you’ll likely consider is commercial real estate. Not only can commercial real estate diversify your investment portfolio, but it can also provide a stable cash flow.
By and large, investing through commercial real estate by purchasing CRE property can be quite beneficial to your business. To begin, however, it is important to secure the right financing for your CRE project.
Thankfully, there are numerous financing options available to you when investing in commercial real estate. This article takes a closer look at mezzanine financing in commercial real estate and its benefits.
Let’s say you wish to purchase a piece of CRE property. To do so, you obtain a bank loan that covers 60% of this purchase. Your out-of-pocket equity contribution covers another 20%. However, there is still 20% of the property’s cost you must cover to purchase.
In this scenario, you have several options. One option could be to increase your equity contribution to cover the remaining 20%. However, increasing equity contribution may not be feasible for some companies.
Instead of trying to raise more equity capital, companies can utilize mezzanine financing. The reason that mezzanine financing works as a solution-oriented option is due to its structure. Specifically, this type of financing option is made to bridge financing gaps like the one seen in our example. Additionally, mezzanine financing in commercial real estate works with your existing CRE loan.
Let’s say you still wish to pursue your CRE project but need a solution that allows you to reduce your equity contribution. Your commercial real estate project’s total cost is $50 million, and you obtain a bank loan for 60% of this cost. This means your bank loan equals $30 million. Currently, your equity contribution is 40% or $20 million.
If this equity contribution is feasible for your company, why might you consider mezzanine financing?
There are numerous reasons why you may wish to reduce the equity contribution of one project. Perhaps you have plans for several commercial real estate projects. By reducing the equity contribution for one project, you can divert that cash elsewhere.
With the aid of mezzanine financing, you can do this without sacrificing one project for another. Instead, you can utilize mezzanine financing to reduce your equity contribution.
An indirect benefit of using mezzanine financing is its impact on your company’s leverage ratio.
Your leverage ratio can be used to calculate several factors about your business. One such factor is your business’ operating expenses using the following debt-to-equity ratio.
Debt-to-Equity Ratio= Total Shareholders’ Equity/Total Liabilities
This debt-to-equity ratio examines the amount of shareholders’ equity and total liabilities in the form of loans your company uses.
How will mezzanine financing impact this ratio?
Companies that have more equity than liabilities may wish to balance out this ratio. The general structure of mezzanine financing combines both equity and liabilities. Some structure examples of mezzanine capital are preferred stock or unsubordinated debt.
So, a company could pursue the unsubordinated debt structure of mezzanine financing and benefit in the long-term with a balanced leverage ratio. Understandably, achieving a better leverage ratio may not be the first reason you pursue mezzanine financing. Nevertheless, how a financing option can benefit your company’s leverage ratio is something to consider when looking at any financing solutions.