Mezzanine Financing

March 15, 2002 -To bridge the gap between a conventional loan from an institutional investor and the equity required to undertake a real estate project, developers have increasingly sought the involvement of mezzanine financing. Though it has been available in the Canadian market for nearly ten years, mezzanine financing is growing both in usage (on behalf of the borrowers) and in acceptance (on behalf of institutional lenders who are providing the rest of the equity on a project). Michael Dosman, Chairman of the Toronto Real Estate Board’s Commercial Division is reporting on this topic.

Despite typical interest rates of 30 to 35 percent, mezzanine financing remains an attractive product for developers because in the end, it’s simply a matter of taking on a loan, far easier, it seems than taking on an equity partner.

"Joint ventures," explains developer Rob Brown, "tend to be a whole lot more expensive at the end of the day than mezzanine money. We’ll continue to use it because it’s just an interest rate and it’s on a small piece of the overall debt."
As part of a four-person panel discussing non-traditional sources of capital for smaller real estate deals at the recent Real Finance conference, Brown president of GenerX Investments and the only borrower at a table of lenders, explains that despite not being an equity partner, mezzanine lenders are partners in a truer sense.

"They’re interested in getting their money in the end – just as we are interested in bringing them out of the deal. With partners, sometimes differences can surface that make it difficult to separate."

WHAT IS MEZZANINE FINANCING?
Brown considers mezzanine financing a form of equity and points to a typical GenerX project, a shopping centre development, as an example. Typically, he can raise 85 percent construction financing, he explains, and the next 12 percent comes from mezzanine financing with about 3 percent of the developer’s money topping it off.

"It’s equity that acts like debt," Brown says. "It’s secured on title but it acts like debt. And mezzanine financiers act like lenders and not equity purchasers."

WHERE DO YOU GET IT?
Mezzanine financing is available from a limited number of sources in the GTA and most developers access this kind of capital through brokers, accountants and lawyers – though some try to access it on their own. But the panel agreed that involving a broker adds significant value to the transaction.

Robert Goodall, president of Canadian Mortgage Capital Corporation and one of the city’s top brokers says what he brings to each deal is experience. This in turn allows him to know who the players are – on the lending side, knowing who can hold things together when the project changes, and from the equity side – knowing the type of lender, he explains, is more important that the liability.

"We tend to work with equity lenders who structure a deal the way we think makes the most sense for that particular transaction. And most mid-market developers don’t have any experience in that area," he says.

WHAT DO LENDERS LOOK AT BEFORE UNDERWRITTING A DEAL?
Warren Appotive of G.E. Capital says knowing the borrower is chief among the things he looks for when assessing a deal (other considerations include product type, location and competition).

With knowing the developers, the lender is also aware of that person’s experience and particularly – their familiarity with the location and the local market.

"If somebody comes into the market I’ve never done any business with," says Appotive, "I ask myself, why aren’t local developers looking at this opportunity."

"But Warren deals with well-capitalized, solid players," says Tim Bankier of the Rose Corporation. "We deal with people that sometimes have no experience and no money."

Bankier says much of his time is spent analyzing the risk of the project itself (as opposed to the individual) and looking at its profitability. It’s a matter of controlling the risk, says moderator Michael Nisker of Equivest Capital Group.

"All of us take a risk that is commensurate and sometimes greater than the developer – from a certain perspective," he explains. "You can’t show me a deal that’s good enough to do where there isn’t any level of discomfort where you’re putting out risk capital. The borrower and lender need to have a relationship and in the end, [the lender] is a partner."

The panel, made up of lenders Rob Goodall of the Canada Mortgage Capital Corp, Warren Appotive of G.E. Capital, Tim Bankier, vice president of the Rose Corpration, a private Toronto based merchant bank, developer Rob Brown, president of GenX Investments Inc. and moderated by Michael Nisker, president of Equivest Capital Group Limited, examined the place of mezzanine financing in Canadian real estate transactions today at the Real Finance conference in February, 2002.

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03/02