Residential property developers, like many businesses, will often need an injection of cash in order to turn an idea into reality.

Unless they happen to be sitting on a small fortune of their own, they’ll require a specialist lender to provide them with the funds they need in the form of development and, potentially, mezzanine finance.

We often work with developers that are looking to secure the funds to make their vision a reality.

The development finance Dragonfly provides can help developers with the acquisition or refinance of buildings or sites and their subsequent development to provide residential units for sale or letting.

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While development finance is pretty easy to get your head around – it says what it does on the tin – mezzanine finance gives the impression of being about the hardest thing ever to understand, so ghastly and inaccessible is the term.

The reality is quite the opposite.

Mezzanine finance is actually quite straightforward. It comes into play when there is a gap between the finance offered by a lender and the developer’s own funds or equity.

It could be, for example, that a lender is prepared to stump up 70% of the cost of a development, but the developer only has 20%. In cases like this, mezzanine finance steps in to bridge the gap and take care of the 10% shortfall.

In construction terms, a mezzanine is described as ‘an intermediate floor between main floors of a building’, and this is a useful analogy when understanding how it works. It’s simply an additional layer of funding offered by a secondary (or ‘junior’) lender to enable a deal to go ahead.

Lending criteria

It goes without saying that every specialist property finance company will have its own set of lending criteria to determine who it will work with and how much it will lend. Criteria will also change with the nature of the economic environment and confidence generally.

At the moment, confidence is improving, as highlighted in early June by the latest CIPS/Markit Construction PMI for May, which saw a strong rise in new orders and confidence. But we’re not out of the woods yet.

For example, Dragonfly only provides development finance to experienced developers with a proven track record in residential development, while our minimum loan size is £500,000. Currently, we will also only lend on developments within prime areas of London.

Regarding LTVs, we go up to 65% Gross Development Value (what the property is worth at the end) and up to 70% of development costs. On first charge loans, we charge from 1.1% per month, on second charge loans from 1.5% per month. We also charge a 2% arrangement fee and require a quantity surveyor to represent us on all deals, with the cost being paid by the borrower.

In terms of the duration of the loan, we will lend for the build period and a six-month sales period. Again, timeframes will vary from lender to lender.

Assessing an application

When assessing an application, we require information on a few key areas.

Firstly, we assess the developer’s previous projects, analysing how they were undertaken and, most importantly, their outcome. This is important in determining the practical capability of the developer.

Secondly, a full development appraisal is required where we will go through all the figures and make sure that they make sense. If the figures and track record look good, we will visit the site, meet the people involved and then do the maths.

Does the deal stack up, will the development sell, what about previous developments in the area, etc? It’s a form of enhanced due diligence, if you like.

We then look at the client contribution, i.e. how much of their own funds the client is prepared, or able, to put into the development.

Much like a deposit on a house, a larger client contribution is looked upon favourably when it comes to securing development finance.

Mezzanine finance

With mezzanine finance, the same criteria apply, but as the risk is higher – mezzanine loans are second charge loans – the application process is slightly more detailed.

Whether lenders offering mezzanine finance decide to proceed in the first place will depend on the nature of the Deed of Priority (also referred to as an ‘intercreditor agreement’) between themselves (as the junior lender) and the ‘senior’ lender that has the first charge.

The Deed of Priority is essentially a contract under which two or more creditors agree among themselves the order of priority in which their respective security from a common debtor will rank.

Basically, it is a contract that provides both lenders on a development with the confidence to proceed, as they will both need to be given the relevant assurances.

Probably the best way to explain mezzanine and development finance is to look at working examples.

Earlier this year we were approached by a client developing a property in Kensington that had, midway through the project, seen its loan facility reduced by the bank and therefore had a critical shortfall of funds.

We assessed the development, crunched the numbers and agreed to make a second charge mezzanine loan on it of £2.5m, which covered the end of the build and the sales period. The property is soon to go on the market for £18m.

On the development finance side, we offered a £12m facility recently on a high end development at One Hyde Park Place. The development was the conversion of an office and commercial premises into a five-storey Georgian house totalling some 16,200 sq. ft.

The 24-month loan we provided has enabled the borrower to repay its existing loan, carry on with the development over an 18-month period and sell it during a period of six months.