ANZPJ Mar16 Mezzanine
ANZPJ Mar16 Mezzanine
ANZPJ Mar16 Mezzanine
THE
RISE
OF
the capital requirements on banks, to the ABS. This reflected an up to 50%5. The development sector
with the average risk weight on increase of 14.7% year-on-year. was one of the hardest hit during the
Australian residential mortgage The rapid growth in housing downturn. Defaulting mezzanine
MEZZANINE
exposures increasing from finance has corresponded with a loans were a major contributing factor
approximately 16% to 25%. stronger demand for mezzanine to Octaviar subsequently being placed
APRA’s regulatory requirements
have had an immediate impact on
DEBT
the Australian housing market, with
auction clearance rates slipping to
REAL ESTATE PLAYERS MUST UNDERSTAND
62.1% for the December quarter of
THAT THE INTRODUCTION OF MEZZANINE DEBT
2015 according to CoreLogic RP Data.
WILL RESULT IN A LESS ROBUST FINANCIAL
Buyers are slowly regaining leverage
STRUCTURE AND A HEIGHTENED SENSITIVITY
as the pendulum begins to swing
TO MACRO-ECONOMIC HEADWINDS.
back, but still in an environment
where finance is more difficult debt. We expect this demand into liquidation. As one disappointed
Following tighter regulatory requirements from senior lenders, property investors to secure and competition for the to accelerate in the near term retail investor explained, “I am bitterly
limited source of available capital for several reasons, including disillusioned … that our hard-earned
and developers can consider mezzanine debt to secure finance. Trident real becomes fierce. Unsurprisingly, increasingly strict lending policies savings were going into mezzanine
estate’s COSTA ARGYROU and SHIRLEY SONG explain the risks and benefits. the need for alternative funding by the big four banks, the surge loans for shonky, over-geared
sources is increasing. in construction and property Australian developers who, when
M
development, the low interest rate things got tough, disappeared into
ezzanine debt While mezzanine finance has the STRICTER LENDING PAVES THE environment, and the unattractive a mix of smoke and mirrors.”6
is set to become benefit of increasing a borrower’s WAY FOR ALTERNATIVE FUNDING MEZZANINE FINANCE alternatives to mezzanine debt such
an important expected return for equity, and The Sydney property market is IN REAL ESTATE as introducing an equity joint venture
source of capital reducing equity needs, this comes currently a hotly debated topic. In real estate, mezzanine finance is partner, resulting in the ceding of TYPICAL DEAL TERMS
for real estate at a cost in the form of higher debt Price growth of 17% and 14% over used in three distinct categories — control and profits to third parties. As a rule of thumb, a mezzanine
investors and developers looking repayments (impacting cash on cash the last two years respectively has property development, investment Real Estate players must provider will provide 10% more
to refinance following the tougher returns), increasing the probability of lifted the median house price to properties and value-add properties. understand that the introduction gearing than the senior debt provider.
capital regulatory requirements default. Understanding the real risk of an estimated $960,000 at June The Australian residential real of mezzanine debt will result in For example, in a development project,
and tighter underwriting mezzanine debt is critical in order to 20153. In the short term, this price estate market is now worth $5.7 a less robust financial structure the mezzanine financier may lend up
by the big four banks. weigh-up whether the expected return is growth is expected to continue, trillion dollars. In August 2015, and a heightened sensitivity to to 75% loan-to-value (net) and 90%
Mezzanine finance bridges commensurate with the additional risk albeit more moderately, given the the value of outstanding housing macro-economic headwinds. loan-to-cost, and will often take a
the gap between senior debt and transaction complications involved. low interest rate environment set loans financed by banks reached The demise of Octaviar presents view on land value uplift. All other
and equity investment, with the Recent research conducted by the Centre by the Reserve Bank of Australia $1.37 trillion dollars, enjoying an a cautionary tale of the heightened
mezzanine lender sitting above of Private Equity Research (CEPRES)1 (RBA), the state’s dwelling deficiency increase of 8.4% for the year4. risks associated with mezzanine
equity in the capital structure shows that, on average, mezzanine and strong investor demand. In the 12 months leading lending. Octaviar, formerly known 5A
ccording to Ferrier Hodgson, in their
but subordinated to the senior loans have a default rate2 of 16.1%. To curb excessive risk taking up to August 2015, the total as MFS Limited, was a Queensland paper titled “Queensland Property
Buffeted by An Ill Wind”, the GFC may
debt. Mezzanine finance appeals in the property market, the value of building approvals for based property finance group. As a have initiated Queensland’s property
to a certain class of borrowers Australian Prudential Regulation residential construction equated specialist mezzanine lender, Octaviar market downturn, but the sector suffered
as it is cheaper than their own 1 See Centre of Private Equity Research. Authority (APRA) has increased to $65.39 billion, according raised funds from retail investors, multiple blows ranging from lower
Private Debt Market Report Q2/2015. Rep. levels of net migration to the downturn
cost of equity and avoids the promising high yields of up to 8% in tourism, the devastating Queensland
Munich: CEPRES GmbH, 2015. Web.
loss of control and potential per annum. The impact of the Global floods and Cyclone Yasi, along with an
2C
EPRES defines the term default rate to ongoing lack of finance.
complications introduced by an 4 Australian Bureau of Statistics (ABS) Financial Crisis (GFC) resulted in the
mean the number of transactions with 3 BIS Shrapnel. “Residential Property
equity joint venture partner. cash on cash multiple <1 divided by the Prospects 2015-2018”. N.p., June 2015, “Housing Finance Australia, collapse of the Queensland property 6 “Investors Back Octaviar Offer of
number of all transactions. 2015. Web. Aug 2015”, Australian Bureau of market, with asset values falling by Cash Payout”. Stuff. N.p., n.d. Web.
Statistics, Canberra. 07 Jan. 2016.
a borrower sells the asset, assuming between the mezzanine lender in order to discharge the debt,
the subordinated debt is not under and the senior financier. interest and other fees owing to
water, the proceeds are used to repay Many senior creditors will the senior lender. Any residual
the principal interest and fees owed typically refuse to negotiate deeds funds remaining are then used
to the senior and mezzanine lender. of priority, particularly if the loan to repay the mezzanine lender in
Alternatively, where a property has already closed. However, senior priority to the shareholders.
has made significant capital gains, creditors do often accept that The senior lender may also
appoint an administrator, with
a view of entering into a deed of
company arrangement (a DOCA).
SENIOR CREDITORS DO OFTEN ACCEPT THAT A DOCA binds all stakeholders,
MEZZANINE LENDERS CAN BRING VALUE including secured and unsecured
TO THE TABLE, PARTICULARLY WHERE THE creditors, and governs how the
MEZZANINE LENDER IS AN EXPERIENCED REAL borrower’s affairs may be dealt
ESTATE PLAYER. with. According to Ryan Spooner,
a director at Ferrier Hodgson, “the
refinancing allows a new first mezzanine lenders can bring value to terms of the DOCA are flexible,
mortgage to take out the original the table, particularly where with the majority of creditors
senior and mezzanine provider. the mezzanine lender is an motivated to accept a DOCA
In a development project scenario, experienced real estate player. proposal on the basis that the return
the mezzanine debt will be Active mezzanine managers may is greater than a liquidation, or the
introduced to fund part of the reduce default rates with better agreement increases the prospects
development costs, along with the access to information and earlier for a turnaround to occur”.
construction loan. The mezzanine intervention strategies, as well as
debt will have the interest capitalised terms structured to protect on the
during the duration of the project. downside, and by ensuring a seat at CONCLUSION
On the pre-sales settlement date, the table in the event of default 8 . Sophisticated quality underwriting
the proceeds from the off-the-plan Unlike the senior lender, a by mezzanine lenders is critical
sales are used to pay down the mezzanine lender will not be for real estate investing in the
construction loan, along with the permitted to enforce their security. current lending environment, with
mezzanine debt (a balloon payment). Often the only commercial a strong focus on exit strategies
Alternatively, refinancing and alternative is to cure the default and timing, in addition to the
granting of the permanent loan by refinancing the secured past record and experience of
post practical completion of the property, or taking out the senior the real estate borrower.
project means that new, cheaper lender at par value (subject to all Real estate players must analyse
finance can generally replace the the prepayment penalties)9. the downside scenarios when
more costly construction loan Should the mezzanine lender running their feasibility models.
and mezzanine funding 7. not wish to exercise its right to cure What are the consequences if
or take out the senior loan when property values decline as they
default is subsisting, the senior did during the late 1980s and early
MEZZANINE LENDER lender may appoint a receiver 1990s? How are property cash
RIGHTS AND REMEDIES to realise the secured property flows, capitalisation rates and exit
In the event of a default, a strategies impacted by the upward
mezzanine lender is restricted movement of interest rates?
by those limitations set out in Borrowers must decide if the
8 “ Mezzanine Debt Offers the Best of
the ‘Priority Deed’. The Priority Both Worlds…or Does It? ” Investment increased returns justify the additional
Deed is an important document Magazine. N.p., 4 Sept. 2009. Web. risks and costs that accompany the
governing the relationship 9A
mezzanine lender will only exercise introduction of mezzanine debt.
its right to cure defaults, or its right to
purchase the senior debt, when the This article has been reduced for
subordinated lender believes they can
7T
his assumes that enough value will have take control of the secured property and publication. To access the full
been created for the construction lender increase its value, or where the secured original paper with more details,
and mezzanine provider to be taken out at property’s value is greater than the sum visit http://bit.ly/1mYLFDe.
the conclusion of the project. of all outstanding security.
FINANCING
is the lowest of all dilutes the equity, or
of the layers in the buys out the equity.
stack due to its This sort of finance
security interest is common
in the collateral. in the US.
DEVELOPMENTS
to the senior debt. The of financial resources
mezzanine debt may be from many different
further split into different individuals to convert
ranking tranches in larger an idea into a project or
project. Each tranche of Information supplied by Trident Real Estate Capital.
business. This can rely on
mezzanine debt may be a few large donors, or many
ranked in accordance with small ones. Funding needs and
where it sits in the capital purposes are communicated
stack and each tranche may broadly, in a forum where this
have different characteristics, can be evaluated by the ‘crowd’,
which can be tailored BONDS (SECURED DEBTS) or audience, usually carried
to meet an investor’s Stricter lending requirements have resulted in out on the Internet.
preference. Rates of return large and reputable developers tapping into the capital
are tied to seniority. markets as a source of finance. Bonds are typically issued
at a fixed rate and maturity, and generally secured against
the overall asset backing of the company. Where there is an
existing bank loan, the securitisation of the bond instead relies on a
‘negative pledge’ that works to contain the issuing company’s debt level.
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