The Makeup of Property Finance.
The Makeup of Property Finance.
What is the makeup of property finance? This article is all about the different ways that you can look to finance your property deals.
So, let’s get straight to it…
If we look at a diagram that shows you have 0% of lending at one side and on the other end of the scale you have 100% lending, there are various different parts of the journey that make up the lending that you receive.
The first part of the lending...
The first part of lending that you are going to get is the senior debt lending. This is going to be things like your brokers, your challenger banks or even your high street bank that arranges the first part of the lending. Typically, this lending will be anywhere between 50-80%.
I have taken some liberties here as there isn’t a generic fixed model, so I have tried to give typical examples of where you are going to get to. This first part of the lending is going to cover you between 50% and 80% of the entire cash that you will need to proceed and do the development.
The second part of the lending...
The second part of the lending is known as mezzanine debt. This sits on top of the senior debt. This mezzanine product might even be tied back into the first bank that you were working with or it could be a second back. This mezzanine product is going to take your lending all the way from where you were up to anywhere between 50% - 90% of the lending. So, based on just senior debt and mezzanine debt you could have anywhere up to 90% of the money for your development.
The senior debt is the lowest risk because they get first charge security. This means if anything goes wrong, they are the first people that get paid back. Now because they are taking the lowest risk, they charge the least amount of money to borrow that first part of capital. On average the banks will be looking for anywhere between 3-8% in interest. This interest rate is known as a coupon, but all it is, is an interest rate.
The mezzanine finance partner will take second charge, this means that they are at a slightly higher risk therefore they want to charge slightly more for the money. They are going to charge anywhere between 8-15% as their coupon. However, very often the mezzanine lender will do it on a monthly basis as opposed to an annual basis. Therefore, you might see that cost recorded as 15 a month. So, the combination of the senior debt and the mezzanine debt leads to something known as a blended rate. The blended rate is simply the percentage coupon rate of both the senior debt and the mezzanine debt combined together to give you one blended rate. This whole first section is known as the institutional part of your journey and it gives you one percentage. For example, to combination of both the senior debt and the mezzanine debt could provide you with a total blended rate of 80%. You would then need to go out and get an equity debt for the remaining 20%.
The final part of the lending...
The final part of the lending is something called equity debt. The equity debt is the part that doesn’t really come from a bank, it comes from a different person such as your own pocket, a JV partner or even a local business that wants to work with you. Typically, the equity debt is the only part of the lend that doesn’t come through from an institutional party. Even though it is called equity debt it still attracts a coupon, even if it is your own money. This is because you need to account for opportunity cost. This coupon charge could be anywhere from 5% to 10%. Another thing to mention with equity that is that if you are working with a JV partner, this is the highest risk element because it is the third seat in the deal. because this is the highest risk element to the financing it usually attracts a profit share. Therefore, if you go to a third party looking for your equity debt, you will find that you will have to give away a property share.
Anything that comes before the equity debt line, is all part of the deal cost. After the equity debt line, you have a small part of dealing costing based on your coupon, but you also have a profit share that is accounted for separately.
None of these figures are facts, these are all generalisations of around where the money comes from.
So, this is the general makeup of the development finance. it is slightly different in the buy to let space because it is less complicated. This information actually took me years and years to learn and I think through demonstrating it in this format it should provide you with great clarity about how it all works.
The more depth that you get around understanding this, the easier it will become for you to make decisions and understand the finance part of your property journey.
I have created a video all about the makeup of finance which could be useful to you. if you are interested in watching it and want to gain a greater understanding, you can find out more on my YouTube channel. Just search Dan Pattrick.