Mezzanine loan and equity partnership: pros and cons
Investors can invest in value-added projects (construction or renovation of real estate) in two ways:
– Providing a mezzanine loan (mezzanine financing): the investor gives the developer a loan in exchange for interest on the loan, and sometimes, as an additional incentive, and in exchange for a portion of the project’s profit (equity kicker).
– Equity partnership: the investor provides the developer with equity capital, participates in the project and makes a profit from its implementation.
Each of the two strategies has pros and cons, which the investor in a development project abroad should be aware of.
Read more about Tranio value added projects.
In case of mezzanine financing, the investor receives interest on the loan. In addition, the lender may claim additional remuneration from the net profit of the project in the form of securities: warrants or options. On average, a mezzanine loan brings the investor an income of 5-10% per annum on invested capital.
The share partner receives a portion of the profits from the project. Its size is determined by a number of factors: the cost of capital in the market, the value of the developer’s investments, the quality and location of the project. On average, an investor can count on 10–20% per annum on invested capital.
The assessment of the riskiness of the two strategies is related to the turn in which project participants make a profit. The mezzanine investor makes a second profit after the bank, which removes it from the risk of losing the invested capital. For him, it is important how much capital the developer provides, since the latter’s funds protect the mezzanine in the event of a negative scenario.
The equity partner is protected worse: he makes a profit after the mezzanine investor and, if the project is unprofitable, the first after the developer will suffer losses. However, with a share partnership, the profit growth potential is greater, and this scheme will be more profitable if the project is successful.
For an investor, a less flexible mezzanine loan is more reliable: it receives fixed payments in a predetermined time frame. The profit of the equity partner depends entirely on the success of the project, so such flexible conditions may not be in his favor.
At the same time, a mezzanine loan is more flexible financing conditions (regularity of payments, debt repayment, interest rates, loan period) compared with a bank loan and is not always supported by collateral.
The question of investor participation in the project is decided in the negotiation process. As a rule, the equity partner has a greater influence on making key decisions than the mezzanine investor, because he is less protected from the risk of capital loss. The mezzanine investor, in turn, can acquire a representative with the right to vote on the board of directors.
Less flexible, but simpler and more defined (fixed payments and payment terms)
Less defined, but more flexible (payouts depend on cash flow)