You’ve found the perfect development opportunity – an £800,000 project with solid profit potential. Your lender offers 65% loan to value, but that leaves you needing £280,000 of your own money.
You ideally want to keep some capital free for other opportunities, but you’re not sure what your options are.
Many property developers face this exact dilemma.
You know straightforward development finance is the cheapest option, but it doesn’t cover your full funding needs. You’ve heard about mezzanine finance but worry it might be too expensive or complex.
Without understanding these two funding types properly, you could either miss out on profitable projects or choose the wrong financing structure that ties up too much of your capital.
In fact, they work together to create a complete funding solution that maximises your leverage while managing risk effectively.
Senior Debt: The Foundation of Development Finance
Think of senior debt as the foundation of your funding structure.
It is usually the largest amount of money borrowed, with the largest LTV and is secured with a first legal charge.
Just as a building’s foundation supports everything above it, senior debt provides the stable base that makes most property developments possible.
This could be structured as:
What Makes Senior Debt “Senior”
The term “senior” refers to its position in the repayment queue – if things go wrong, senior debt holders get paid first from any asset sale or refinancing.
This preferential treatment makes senior debt the lowest-risk option for lenders, which translates into better terms for you as a borrower.
Interest rates are lower than other forms of development finance because lenders have the security of knowing they’ll be first in line for repayment.
A senior lender will place a first legal charge over your development site, giving them the primary claim on the property.
In today’s market, senior debt lenders will advance between 60% and 70% of a project’s gross development value (GDV), though some specialist lenders push this slightly higher for experienced developers with strong track records.
Factors Affecting Your Borrowing Capacity
The exact percentage depends on several factors.
Your development experience carries significant weight – first-time developers might struggle to achieve more than 60% GDV, while established developers with successful track records can often secure 70% or more. Project location matters, with lenders more generous on developments in proven markets with strong demand.
Application and Funds Release
When you apply for senior debt, lenders focus heavily on the project’s viability. They’ll want to see detailed development appraisals showing realistic costs and sales values, plus evidence of planning permissions and your understanding of construction timelines.
The application process starts with an initial assessment where lenders evaluate your proposal’s feasibility.
You’ll need to provide financial projections, construction schedules, and market evidence supporting your sales assumptions. If they’re interested, you’ll move to a more detailed application stage involving professional valuations, legal due diligence, and credit checks.
Most senior debt facilities complete within 4-8 weeks, assuming all documentation is in order. However, this timeline can extend if valuations are delayed or legal issues arise.
Once approved, you’ll receive funds in stages tied to construction progress.
How Staged Payments Work
After the initial payment, the lender’s surveyor will inspect the site and confirm milestones have been reached before authorising the next payment.
A typical release schedule might include 25% on exchange of contracts, 25% at foundation completion, 25% at first fix stage, and the final 25% at practical completion.
This staged approach might feel restrictive initially, but it actually helps with cash flow management and ensures you’re not paying interest on money you don’t yet need.
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Mezzanine Finance
Mezzanine finance occupies the space between traditional senior debt and equity investment. It’s called “mezzanine” because it sits in the middle of the capital stack– not quite debt, not quite equity, but a hybrid that combines features of both.
The Hybrid Nature of Mezzanine Finance
Unlike senior debt finance, mezzanine finance often includes profit-sharing elements or equity kickers that allow the lender to benefit from your project’s success.
This might involve a share of profits above a certain threshold, warrants giving the lender rights to buy into your development company, or conversion features that turn debt into equity under specific circumstances.
Mezzanine lenders take a second charge over your property, meaning they’re repaid after the senior debt holder but before you receive any equity returns. This higher risk position justifies the significantly higher interest rates that mezzanine finance commands compared to senior debt.
The Growing Mezzanine Market
The UK mezzanine market has grown substantially as property developers seek ways to reduce their equity contributions while scaling their businesses.
With main lenders becoming more conservative post-2022, there’s an estimated £12.8 billion funding gap in the UK property sector that alternative lenders, including mezzanine providers, are helping to fill.
What makes mezzanine finance particularly attractive is its flexibility.
Terms can be structured to suit specific project needs, with options for rolled-up interest payments, profit deferrals, or staged equity participation. Some mezzanine lenders also provide strategic guidance, leveraging their industry experience to help developers avoid common pitfalls.
Typical Mezzanine Structures
The typical mezzanine finance arrangement might provide top-up funding equal to 15-25% of your project’s GDV, taking total leverage up to 75-85% when combined with senior debt.
This dramatically reduces the cash equity contribution required from developers, freeing up capital for other opportunities or providing breathing room for unexpected costs.
Senior vs Mezzanine
The differences between these funding types go far beyond simple cost comparisons, though cost remains a significant factor in most decisions.
The very nature of mezzanine loans means that you need to have a first charge main loan in place already, typically offering 60-75%. Mezz loans then allow you to borrow beyond these LTV limits.
Risk and Repayment Hierarchy
The most fundamental difference lies in risk and repayment priority.
If your project encounters financial difficulties, senior debt holders have first claim on any proceeds from asset sales or refinancing.
Mezzanine lenders are next in line and have to wait their turn, which explains why they charge higher rates to compensate for this additional risk.
This hierarchy affects more than just interest rates though.
Senior debt lenders often have greater influence over major project decisions, including the right to step in if things go wrong. Mezzanine lenders might require board representation or approval rights over significant changes, but they generally allow more operational flexibility day-to-day.
Costs and Fees
While senior debt loans might carry rates of base rate plus 3-5%, mezzanine finance often costs 12-20% annually, sometimes with additional fees or profit participation requirements.
However, this isn’t necessarily as expensive as it first appears when you consider the reduced equity requirement and potential returns on the capital you’ve freed up.
If releasing £100,000 of your own capital allows you to invest in another project generating 25% returns, the 15% cost of mezzanine finance becomes more palatable.
Both funding types involve fees.
Senior debt arrangements often include arrangement fees of 2% plus legal and valuation costs. Subordinated mezzanine finance can carry higher arrangement fees but offer more flexibility on timing and structure.
Qualification and Documentation
The qualification process varies considerably between the two options.
Senior debt lenders focus primarily on project viability, your development experience, and the strength of your exit strategy. They want to see realistic financial projections and evidence that you understand construction management.
Mezzanine providers dig deeper into your business strategy, growth plans, and ability to service higher-cost debt while delivering projected returns.
They’re often more interested in your long-term vision and how this project fits into broader business objectives. Documentation requirements can be more extensive, particularly around business plans and financial forecasting.
Who Benefits from Each Funding Type?
Your choice between senior debt, or a combination including mezzanine finance, depends largely on your experience, capital position, and growth ambitions.
First-Time and Smaller Developers
First charge development finance is the go-to option for virtually every property developer because it provides the cheapest capital available.
Whether you’re doing your first development or your fiftieth, senior debt should form the foundation of your funding structure. First-time developers should focus on understanding senior debt thoroughly before exploring more complex options.
Scaling and Experienced Developers
Mezzanine loans suits developers who want to scale their operations or take on larger projects than their available capital would normally allow.
You need enough experience to handle the complexity and costs involved, plus the confidence that your project margins can support higher financing costs.
More experienced developers often use mezzanine finance strategically.
Instead of putting £300,000 into one project, you might use mezzanine funding to spread £300,000 across three smaller projects, potentially generating higher overall returns despite the increased financing costs.
A Practical Development Scenario
Consider a £600,000 residential development project in Birmingham – perhaps converting a former office building into six apartments. The project requires £450,000 in total costs, including land acquisition, construction, and fees.
Senior Debt Only Structure
With senior debt at 65% of GDV, you’d borrow £390,000, leaving you needing £210,000 of your own money plus working capital for unexpected costs. This might represent most of your available development capital, limiting your ability to pursue other opportunities.
Adding Mezzanine Finance
Adding mezzanine finance to reach 80% total leverage brings in another £90,000, reducing your equity requirement to £120,000.
The mezzanine portion might cost 16% annually compared to 8% for senior debt, but you’ve freed up £90,000 of your own capital.
If that freed-up capital earns 20% returns in another project, you’re ahead despite the higher mezzanine costs. Over an 18-month development period, your additional interest costs might be £10,000-15,000, but the strategic value of preserving capital often outweighs this cost for growing development businesses.
The Strategic Benefits
The numbers become even more compelling when you consider the learning curve benefits.
Using mezzanine finance on one project builds relationships and experience that can benefit future developments, while the preserved capital provides options if market conditions change or unexpected opportunities arise.
Understanding Property Development Capital Stacks
Learn how UK property development capital stacks work. Reduce equity requirements, access more funding & tackle larger projects.
Creating Sophisticated Capital Structures
The most successful developers don’t see this as an either-or decision.
They create what’s called a capital stack – layers of funding with different risk profiles and costs working together to optimise their overall financing.
Building Your Capital Stack
Senior debt forms the base layer, providing secure, lower-cost capital for the majority of project costs.
Mezzanine finance adds the middle layer, bridging the gap without requiring you to bring in equity partners who might want control over project decisions.
Your own equity sits at the top, providing the flexibility and ultimate control that comes with ownership.
This layered approach maximises leverage while managing risk effectively.
Each funding source operates within its comfort zone, and the structure can be adjusted based on project requirements and market conditions. Some developments might use 70% senior debt and 15% mezzanine finance, while others might push senior debt to 65% and increase mezzanine to 20%.
Managing Multiple Lenders
Coordinating multiple lenders requires more sophisticated legal work and documentation.
Inter-creditor agreements define how decisions get made and what happens if problems arise. The additional complexity means higher legal costs initially, but the benefits often justify this investment for larger projects or developers planning multiple developments.
The key is ensuring all parties understand their position in the capital stack and how decisions affect each other.
Experienced legal advisers become essential when structuring these arrangements, as does working with brokers and debt-advisory experts who understand how different lenders approach complex structures.
Getting Professional Guidance
The complexity of modern development finance means that professional guidance often pays for itself through better terms, faster approvals, and access to lenders you couldn’t reach directly.
Access to Specialist Lenders
Specialist finance brokers maintain relationships with hundreds of lenders, including mezzanine providers who don’t deal directly with borrowers. This access means you can compare options across the entire market rather than being limited to lenders you can contact yourself.
Beyond simple introductions, experienced advisers help to structure deals to minimise overall funding costs while maximising your leverage. This might involve negotiating better terms, coordinating between senior and mezzanine lenders, or suggesting alternative structures you hadn’t considered.
Time and Cost Savings
The time savings alone often justify broker involvement.
Instead of approaching lenders individually and explaining your requirements repeatedly, brokers present your case to multiple suitable providers simultaneously. Their established relationships frequently result in faster decisions and more flexible terms than you’d achieve working alone.
Perhaps most valuably, brokers provide ongoing support throughout the process.
Development projects inevitably throw up unexpected challenges, and having someone who understands both your funding structure and lender requirements helps resolve issues quickly before they become serious problems.
Making Your Funding Decision
Your funding choice should align with your development experience, available capital, and business objectives. The right structure can accelerate your business growth while managing risk effectively.
Smaller projects or first-time developers often work best with straightforward senior debt, while larger developments and experienced developers can benefit from more sophisticated structures.
Starting simple allows you to build experience and relationships before tackling more complex funding arrangements.
The Power of Combined Funding
The combination of senior debt and mezzanine finance offers property developers a powerful toolkit for scaling their businesses while managing risk effectively.
Senior debt provides the stable, cost-effective foundation, while mezzanine finance fills funding gaps without requiring equity partners who might demand control over your projects.
To speak with a specialist broker, please call us on 020 3951 2828.
FAQ
Most UK lenders offer between 60-70% of your project’s gross development value (GDV) through first charge senior debt. Experienced developers with strong track records might achieve slightly higher percentages, while first-time developers can face lower limits.
Yes, many developers use both together in what’s called a capital stack. Senior debt might cover 65% of costs, mezzanine finance another 20%, leaving you needing just 15% equity instead of 35% with senior debt alone.
Mezzanine finance carries higher interest rates than senior debt, often 12-20% annually compared to base rate plus 3-5% for senior debt. However, the reduced equity requirement can make the overall structure more profitable.
Senior debt takes a first legal charge over your development property. Mezzanine finance requires a second charge plus it often needs personal guarantees or additional security depending on the lender and project.
Both senior debt and mezzanine finance usually run for 12-24 months, aligning with typical development timelines. Extensions are often possible if projects face delays, though this might increase costs.
Both senior debt and mezzanine finance usually release funds in stages tied to construction milestones. Typical stages include exchange of contracts, foundation completion, first fix, and practical completion, with payments released after surveyor inspections.
