How to invest in a construction project overseas: mezzanine loans and equity partnership
With increasing fervor, foreign buyers are flocking to invest in construction and redevelopment projects, also known as
In fact, across Europe, the proportion of investors opting for
This is largely attributable to yields; global yields are declining. In Europe, you can expect an average
Despite this key advantage,
As such, conventional
Investors can get involved in such projects in two ways:
- Become a mezzanine investor: the investor lends capital to the developer in exchange for a fixed interest for the utilisation of the funds and gets a share in the profits obtained from the project.
- Become an equity partner: the investor provides the developer with equity capital, participates in the project, benefits from operating profits and bears the consequences of the risks inherent to the project.
Each of these schemes has its own advantages and disadvantages.
Mezzanine financing is a hybrid of debt and equity financing. Basically, it is a subordinated debt that has secondary priority after the senior debt – the bank loan. It is secured by a pledge of shares or by equity. The borrower is usually a Special Purpose Vehicle or SPV created by the developer.
The main advantage of mezzanine financing is that they tend to offer higher interest rates than bank loans. In the United States, for instance, interest rates typically range between
In addition to the increased interest rates associated with mezzanine loans, investors can benefit from extra yields, depending on the profitability of the project. This option is known as an "equity kicker" and is typically structured in the form of one of two types of securities: options or warrants.
The scheme of capital distribution with the attraction of mezzanine financing
Compared to simple rental businesses,
The specific risks associated with
At the same time, the bank and mezzanine investor typically maintain a safe distance from the risk. In most cases, the first to earn nothing under a negative scenario is the developer. It is important to verify this in each case before investing.
The developer can choose one of two alternatives with respect to his or her own funds: pay out of pocket or attract an equity partner.
An equity partner is an investor who partially finances the project in exchange for a share in the profits. If an equity partner is involved in a project, his or her capital typically comprises about 20% of the project cost. In this scenario, the partner would shares the risks and profits of the project with the developer.
In this case, the developer provides the remaining 10%
The scheme of capital distribution without mezzanine financing and an equity partner
The developer can also attract the capital of an equity partner without mezzanine financing. Under this scheme, the project is financed by three parties: a bank that provides the primary loan, an equity partner and an investor.
The scheme of capital distribution without mezzanine financing but with an equity partner
As for the distribution of the profits
In 2017, taking into account the current U.S. and European market situations and
In sum, an investor who opts to become a mezzanine lender faces relatively low yields, but also takes on relatively few risks owing to the fact that in the event of bankruptcy, the developer is first to bear losses, followed by the equity partner, with the creditors trailing behind. On the contrary, an investor who opts to become an equity partner stands to earn relatively high profits, but also takes on greater risks.
|Types of capital||Loan||Own|
|Source of profit||Loan interest andequity kicker||Profit fromthe projectrealisation|
|Priority of payments||Second priority(after the senior,[bank] debt)||Third priority|
|Average yield, %||10||15|
This article only reflects the general principles of the relations between the participants of the developer projects.
George Kachmazov, managing partner at Tranio
Originally published on globalrealestateexperts.com