How to invest in German redevelopment projects on a modest budget

European Union (EU) key interest rates recently hit an all-time low. Bank financing is now only 1.5–3% per annum, while yields on fixed deposits, bonds and rental properties have shrunk.

Because of this, investors are now looking for other ways to grow their savings. Many have turned to more profitable strategies known as Value Added projects, which include property construction or redevelopment. Independent participation in such projects typically requires a large budget and experience in the local market. Today, however, investors with smaller budgets can also participate in Value Added projects via mezzanine loans and crowdfunding platforms.

Investors typically provide mezzanine loans to a Special Purpose Vehicle (SPV) a developer creates for a particular project in exchange for a fixed interest for a loan. The developer redeems the mezzanine loan after the senior debt, which is a bank loan. It is possible to invest in a mezzanine loan via crowdfunding platforms, which are collective investment platforms. In Germany, they mostly raise money for micro-apartment or commercial property renovation or construction projects.

Advantages of mezzanine financing

Mezzanine financing is beneficial to investors due to a number of reasons:

• Low entry threshold

While the minimum budget for commercial and residential property purchases in Europe is €100,000 and €1 million respectively, many German crowdfunding platforms offer projects to investors with budgets as small as €500.

• High yields

Unlike rental properties, which yield 3–4% per annum, mezzanine loans yield 7–10%. Developers take out mezzanine financing despite their high interest rates, as the bank loans they receive are often insufficient to fully fund their projects. Mezzanine loans also enable developers to reduce their own investment in the project to 10–30% and, therefore, get a higher return on investment.

• An opportunity for additional yields

In addition to the mezzanine loan interest, investors can count on an additional yield, which depends on 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.

• Moderate risk

Just like a bank, the mezzanine investor typically maintains a safe distance from the risk. The developer is the first to lose capital under a negative scenario. To be on the safe side, it is recommended that investors participate in the projects in which developers put down their own funds. In doing so, they partly assume the risks associated with the project.

• Simplicity and convenience

Investors can sign a loan agreement remotely and transfer money from their accounts. They will receive the interest and the body of debt onto them. Unlike property transactions, these projects do not require waiting for several months, registering title to a property in the Land Register or paying for the transaction.

Project example

Let us consider an example of a real micro-apartment construction project in the federal state of North Rhine-Westphalia. The total cost of the project is €44.8 million. A bank provides 83% (€37.2 million) of this sum, while the developer (€2.6 million) and mezzanine loans (€5 million) make up the balance. The project delivery time is 2 years.

To carry out the project, the developer creates a Special Purpose Vehicle (SPV) to which the land plot is registered and a bank loan is issued. The developer attracts mezzanine investors via Tranio, a crowdfunding platform and its project company. of the sum to be raised from investors, €2.5 million is expected to be provided by investors who contribute at least €2,000, and the other €2.5 million by those who contribute at least €500,000.

The yield rate for mezzanine investors who contribute €2,000 to €500,000 is 6% per annum and 8% for those who contribute more than €500,000. The latter also get an equity kicker in the form of the margin on the resale of the project's shares to the other investors.

Yulia Kozhevnikova, Tranio