Real estate investment can be a very profitable industry if done correctly. The two main components of real estate investment are being able to properly manage finances and salesmanship skills.
This sounds really simple, but when dissected there is a lot to consider and do. There are two main ways to finance the purchase of a piece of real estate.
The first is the called mortgage financing and the other is called equity.
However, sometimes mortgage financing and equity financing are not enough to cover the costs of the real estate. This is when many investors turn to what is called a mezzanine.
Mezzanine is the capital that fills the gap between equity and the mortgage. It is a debt tool that is more expensive than mortgage financing, but lower yielding and cheaper than equity.
This method of financing is more expensive than the other two types is due to the fact that in the event of liquidation, the first mortgage lender has preference over junior capital. Junior capital encompasses mezzanine and equity.
Mezzanine has the second preference and therefore has preference over equity in the event of liquidation and is generally cheaper than equity financing. Mezzanine financing can either be secured or unsecured.
The form of security for a mezzanine is usually a second mortgage. Returns of a mezzanine are created through higher yielding coupons and participation in the equity of the project.
The results of the return on the mezzanine are usually affected by the attitude of the mezzanine investor. Some investors prefer to work with equity and accepting a lower coupon more often than not.
However, other investors prefer to work with debt and will depend more heavily on their coupon. If the mezzanine involves a debt oriented investor, but there is only so much that can be paid on the mezzanine because of contract restrictions, the coupon will have to be separated into cash-pay and accrued payments.
If planning to use accrued payments it is good to know that the accrued interest payments will have higher priority to distributions to the equity. This means that the interest payments must get paid first.
It is also important to be aware that since some of the payments are put off until the mezzanine maturity date, more of the equity will have to be given up than in the case where the payments were made on time. Additionally, it is important try to not allow interest payments to compound as much as possible when accruing payments.
Institutional investors usually depend on mezzanine debt for the purchase of real estate because they must make very large purchases. For smaller purchases, it may be wise for an investor to look into the networking of individual investors.
These investors may find the current yield of the potential secured position more appealing than the equity of a transaction. This way also has the benefit of private placement when marketing to raise more capital.
Mezzanine loans have been known to finance 85-90% of the needed capital. Mezzanine financing depends on the asset being financed, the capital structure of the financing, and whether the asset is considered to be stable or whether it is being repositioned or developed.
A mezzanine can take the form of a traditional second mortgage, a second mortgage with no rights, a tradition mezzanine loan, preferred equity, or equity structured as dept.
There are many advantages to mezzanine financing. One advantage is that the returns are larger.
The mezzanine also does not share in the profits and the return has a limit. This type of financing has much less control of daily operations.
The mezzanine return requirements are typically lower than equity return requirements. Mezzanine financing can be worth the effort if your investment in real estate is successful.
Mezzanine financing can make it possible for you to invest in real estate, although you should never risk the well-being and security of your family.
Tommy Greene has worked since 1991 in property investments. He loves all things financial. He recommends (http://www.stanjohnsonco.com) for your property investment needs.
|
|