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The market for alternative finance for properties though is a growing one, with specific products such as bridging, self-build, development and even agricultural and mezzanine finance becoming increasingly available (source: SPF Loans). There are advantages and disadvantages though to be had as a result of these products’ emergence.
Whilst it is good for borrowers who need funds for specific purposes, applying for the wrong loan can lead to a rejection and therefore a negative mark on the applicant’s credit rating. This would inevitably impact any future applications for a loan of any kind.
Loans such as bridging finance are also very adaptable and can be used for both business and private property purposes. This is also the case with options such as international mortgages and auction finance.
There are however, various products that can only be taken out if the loan if for specific business purposes. This includes mezzanine finance, development finance and stretch senior debt, all of which are either reliant upon the business or need a portion of the business as collateral for the loan itself.
Mezzanine finance combines property debt and borrowing and business equity. It tends to be used for much higher risk ventures and is typically utilised as a second charge loan.
This means that the borrower will usually have another loan; say a mortgage or bridging loan secured against a property and will then take out a mezzanine loan in order to increase the amount of capital available. This is particularly useful for property developers who need to push a deal through quicker than would otherwise be necessary.
This type of finance however requires the borrower to have a business and to be able to potentially give up a percentage of shares [equity] in the business should it be required.
The lender will offer the loan, secured against a portion of the property in the developer’s portfolio.
There will be a clause in the contractual agreement whereby if the borrower cannot repay all or a portion of the loan, the lender will take a percentage of equity in the business which will tend to be a high-risk venture in these cases.
Whilst a higher risk business, lenders will only provide a loan if there is room and clear potential for the business in question to make significant profits as a result of the investment of the loan.
Should the borrower default on the loan, the lender can either sell off the shares in the business to repay their losses or they can hold onto their acquired equity and receive a share of the business’ profits, acting as a shareholder.
With these loans though, there are likely to be additional charges in the shape of legal fees and potential arrangement fees. Moreover, if relevant the project may incur additional fees. For example, if the loan is used to convert a property into multiple living spaces, sound insulation testing will be required (source: https://www.rjacoustics.com/), incurring further costs that should be accounted for from the outset.
Stretch Senior Debt
Stretch senior debt is a unique type of loan, but it is not dissimilar to mezzanine finance in that it combines more than one aspect of funding and business. These loans are pertinent to businesses that have a degree of assets as well as cashflow. For example, a business may have large, predictable and stable cashflow and limited business assets and are therefore not able to easily to secure a loan on the scale of say a bridging loan. By offsetting the difference of what they are unable to borrow against their assets onto their predicted cashflow, they may be able to secure a loan of this nature.
Alternatively, a business may have a large asset base and limited cashflow. They may not be able to borrow against all of their assets and therefore can borrow against the predicted cashflow of the business. Normal, unsecured cashflow loans cannot provide the same scale of investment as secured property loans and this is one of the primary reasons for borrowers turning towards stretch senior debt.
Furthermore, businesses seeking this kind of investment tend to need to combine the two securities; assets and cashflow in order to secure a much larger injection of capital into their business than would otherwise be available to them.
Borrowers must be able to demonstrate clearly to lenders that the risk being taken is of an acceptable level and that the potential return is realistic.
The lender will always require the cashflow-secured portion of the loan to be repaid first as it provides less security than the portion secured against a property or other assets. This type of finance will usually be taken out as a first charge debt though, unlike mezzanine finance which tends to be a second charge secured loan.