Mezzanine finance for commercial property projects

• A developer building a scheme of trade counter or light industrial units has consent and a senior property development finance facility, but the senior lender's loan-to-cost limit leaves a larger equity gap than the developer's available cash.
• An experienced developer wants to run two commercial schemes at once instead of tying all its cash up in one; mezzanine on each spreads the equity further.
• An investor acquiring a let commercial building where the senior commercial investment mortgage lender caps the loan below what is needed, and the rent comfortably covers both layers of interest.
• A heavy refurbishment or change of use of an office or industrial building where conversion finance covers most of the cost and a top-up is needed.

It rarely makes sense on a thin margin. If the scheme's profit only works before mezzanine costs are deducted, the extra layer turns a modest project into a loss-making one.

Mezzanine interest is almost always rolled up and paid on exit, because a development produces no income until it is sold or let. Beyond interest, expect an arrangement fee, often an exit fee, and sometimes a minimum return that applies even if the loan is repaid early. Some mezzanine funders take a share of profit instead of, or alongside, interest; at that point the facility behaves more like equity and the developer keeps less upside.

Total borrowing is measured across both layers. Lenders look at combined loan-to-cost and loan-to-gross development value, and the mezzanine lender sets its own ceiling on how much of the stack debt can fill. Specialist lenders offer a single "stretched senior" loan to a similar combined level, which avoids two lenders, two sets of legal fees and an intercreditor agreement; it is often worth comparing before committing to a separate mezzanine layer.

Illustration (hypothetical round figures): a developer's scheme of small business units costs £2,000,000 including land and fees and is expected to be worth £2,600,000 once built and let. The senior lender will lend £1,300,000. The developer has £300,000. A mezzanine lender provides £400,000 to close the gap. If the finished scheme is worth 10% less than expected, £2,340,000, the developer's profit shrinks and its equity takes the loss first; both lenders are still repaid. If values fall far enough to wipe out the developer's equity, the mezzanine lender is next in line, which is why it scrutinises the valuation and cost plan so closely.

Mezzanine cannot be added without the senior lender's agreement, and some senior lenders refuse it outright. Where they accept it, the two lenders sign an intercreditor agreement (sometimes a simpler deed of priority) that fixes who is repaid first, what the mezzanine lender may do if the project defaults, how long it must wait before acting, and whether it can buy out the senior loan to take control. The mezzanine lender's second charge is registered at HM Land Registry; HM Land Registry's practice guide on registering legal charges explains how priority is recorded. If the borrower is a company, both charges also go on its public record at Companies House, as the GOV.UK charge registration guidance sets out.

Negotiating the intercreditor is one of the slower parts of a mezzanine deal, so choosing a senior lender that already works with mezzanine funders saves weeks. Our guide to debentures and fixed and floating charges explains the security terms you will see in the documents.

Mezzanine increases leverage, and leverage cuts both ways. A cost overrun or a delay in letting consumes profit faster when two layers of interest are rolling up, and many mezzanine lenders ask for personal guarantees, including guarantees that the build will be completed. Read our note on personal guarantees before agreeing to them.

Alternatives include a stretched senior loan, bringing in a joint venture equity partner who shares risk as well as profit, asking the landowner to defer part of the price, phasing the scheme so each phase funds the next, or simply building a smaller first project. Our guide to debt versus equity funding sets out the wider trade-off.