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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 real estate and its benefits.
Businesses are often seeking specific funding for a project or acquisition. That’s where mezzanine loans come in. But what is a mezzanine loan exactly? Mezzanine loans are a combination of debt and equity financing that cover what traditional lenders may not.
Lenders offering mezzanine loans may offer slightly less coverage than a traditional loan while receiving equity. Since these loans vary from typical ones, businesses may face higher interest rates but flexible repayment plans.
Mezzanine financing is a top choice for investors when it comes to real estate. Where a traditional loan may not offer enough, mezzanine financing in real estate is the solution. Investors look to mezzanine loans to provide the missing funding for acquisitions or development projects.
Since mezzanine loans are a combination of debt and equity financing, they often don’t require physical collateral. Instead, this loan allows investors to reach a higher return on their investment without needing to sell a similar level of equity. Working with a professional lender can help you secure the real estate funding you need to grow your investment and take your projects to the next level.
Let’s take a look at just a few of the benefits that come with choosing a mezzanine loan for real estate.
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.
When it comes to mezzanine financing in real estate, lenders tend to take a more hands-off approach. That means that investors often still maintain full control of their property. They’ll have the final say in what is happening with their property while still receiving the funding they need to move forward with projects.
Though mezzanine loans may have higher interest rates, they often come with a shorter term and a flexible repayment plan. In some cases, you may be able to repay your loan at the end of the term as opposed to during. If this is the case, you’ll have more time to focus on your investment and growing your projects so you can easily afford the repayment at the end of the term.
Mezzanine loans are not always a viable option for every real estate investor. Luckily, there are other funding options available to help you achieve your real estate goals.
From small business loan acquisition to bridge loans, AVANA Capital can provide you with the funding you need to grow your real estate business. AVANA Capital is passionate about creating financial solutions for commercial real estate professionals who are making a difference in their communities. Bring your development projects to life with a repayment plan that works for you. Speak with our lending experts today to learn more about mezzanine loan alternatives available to you.