Understanding the precise make-up of the capital stack within Property Development has become increasingly more important for developers in today’s environment.
For the purposes of this article, I am going to keep things very high level (feel free to reach out to me directly if you want to get into more detail).
There are usually two levels of capital raising when it comes to getting a project funded and out of the ground. Below are examples of the typical structures of funding (referred to as the Capital Stack) commonly used in Non-Bank Construction Lending.
Senior Debt (First Mortgage)
This Debt takes priority over other more junior debt (essentially the Senior Debt holders are the ones getting their money back first, hence this is reflected in their interest charge compared to a Mezzanine Funder)
Mezzanine Debt (2nd Mortgage)
Typically funded by Non Bank Private Funders and ranks behind the Senior Debt (First Mortgage), this means they are getting there money after the Senior Debt holder so they tend to charge a higher interest rate compared to the Senior Debt holder.
Why would a Developer take on Mezzanine Debt and pay a higher interest rate on the Mezzanine portion? Taking on Mezzanine Debt simply means the developer does not need to contribute as much equity to the deal.
Essentially they are borrowing a portion of their equity contribution instead. As the rates and fees can be significantly higher on Mezzanine Debt, Developers should ensure their feasibility study reflects the additional costs to ensure the project still remains feasible.
Equity Contribution
Typically funded by the developer themselves, and as such, the developer is the last party to get their money back, in saying that if all things go well, they usually obtain the highest return on investment.
