Mezzanine Finance in City of London

Mezzanine finance is a form of secondary or subordinated debt that sits behind senior development finance in the capital stack. It is secured by a second legal charge over the development property and fills the gap between what the senior lender will provide (typically 60-70% LTC) and the amount the developer needs to minimise their own equity contribution. Mezzanine finance typically brings combined leverage up to 80-90% of total project costs, meaning the developer only needs to contribute 10-20% from their own funds.

Mezzanine finance works alongside senior development finance in a layered structure. The senior lender provides the majority of funding (typically 60-70% LTC) secured by a first charge. The mezzanine lender provides additional funding (typically 15-25% LTC) secured by a second charge. The two lenders enter into an intercreditor agreement that governs their respective rights, priorities, and enforcement procedures. The mezzanine lender accepts higher risk in exchange for a higher interest rate, and the senior lender's position is protected by priority of repayment.

With mezzanine finance layered on top of senior development debt, combined leverage of up to 90% of total project costs (LTC) is achievable for strong projects with experienced developers. A typical structure might be 65-70% senior debt plus 20-25% mezzanine, leaving the developer to contribute just 10-15% equity. The exact maximum depends on the project quality, developer track record, GDV projections, and the senior lender's willingness to work with a mezzanine facility behind them.

Mezzanine finance rates for City of London developments typically range from 1.0% to 1.75% per month (12-21% per annum). Rates are higher than senior development finance because the mezzanine lender takes a subordinated position with higher risk. The rate depends on the overall LTC, project quality, developer experience, and exit strategy. When calculating your total cost of finance, consider the blended rate across both senior and mezzanine facilities rather than looking at each in isolation.

An intercreditor agreement (ICA) is a legal contract between the senior lender and the mezzanine lender that governs their respective rights, obligations, and priorities in relation to the development project. It covers key matters including priority of payments (senior debt is always repaid first), standstill periods during which the mezzanine lender cannot enforce, cure rights allowing the mezzanine lender to remedy senior defaults, and consent requirements for various actions. The ICA is critical because it ensures both lenders can work together efficiently and protects each party's interests.

Mezzanine finance involves two separate lenders providing two separate facilities: a senior lender on first charge and a mezzanine lender on second charge. Stretched senior is a single facility from one lender at a higher LTC than standard senior debt, typically up to 75-85% LTC. Stretched senior is simpler and faster because there is only one lender, one set of legal documents, and no intercreditor agreement. However, mezzanine can typically achieve higher leverage (up to 90% LTC) and allows you to shop separately for the best senior and mezzanine terms. We advise clients on which approach is optimal for their specific project.

Mezzanine finance for first-time developers is more challenging but not impossible. Most mezzanine lenders prefer to work with experienced developers because the higher leverage increases risk. However, for first-time developers with a strong project team, a clear and conservative appraisal, and a slightly higher equity contribution, we can access mezzanine facilities. We recommend first-time developers consider mezzanine finance for smaller, lower-risk projects such as light refurbishment or straightforward conversions rather than complex ground-up builds.

Mezzanine finance drawdowns can be structured in several ways depending on the lender and project. The most common structures are: day-one drawdown where the full mezzanine facility is drawn at completion and the interest is rolled up; staged drawdowns aligned with the senior facility where mezzanine is drawn pro-rata alongside senior debt; and back-ended drawdown where the senior facility funds the initial project stages and mezzanine is drawn in later stages. Each structure has different cost implications, and we help developers choose the most efficient drawdown profile for their project.

The exit strategy for mezzanine-funded projects is the same as for any development finance facility. Upon completion, both the senior and mezzanine facilities are repaid from either the sale proceeds of completed units or refinancing onto longer-term debt. The key consideration is that both facilities must be cleared, so the exit needs to generate sufficient capital to repay all debt. For City of London projects, strong end values and reliable demand typically provide comfortable exit coverage. Lenders assess the exit at the outset and will not proceed unless the projected exit comfortably covers all borrowings.

Arranging mezzanine finance typically takes 2-4 weeks on top of the senior debt arrangement timeline, because the mezzanine facility cannot be fully documented until the senior terms are agreed and the intercreditor agreement is negotiated. For developers who need speed, we can run the senior and mezzanine processes in parallel, identifying the mezzanine lender while the senior facility is being arranged. In some cases, we can also arrange both facilities from the same lender or fund group, which eliminates the need for an intercreditor agreement and reduces the overall timeline.