In this publication we present that the combined model in private credit in property stands out as particularly attractive. By blending the features of mezzanine finance and equity, this approach provides a compelling balance of risk and reward. The dual structure — offering interest income alongside profit-sharing — delivers enhanced returns while mitigating risks through second-charge security and stringent oversight mechanisms. For investors seeking to diversify their portfolios and capitalise on the growth opportunities in property development, the combined model represents a versatile and high-potential option. As the market continues to evolve, its innovative structure and adaptability are likely to further bolster its appeal.
In our previous articles, we delved into the advantages of private credit in a falling interest rate environment, analysing its role as a diversification tool for investors (LINK). We have examined various private credit types, highlighting their capacity to enhance returns and provide flexibility amid evolving market dynamics (LINK). In this article, we shift focus to five key strategies within private credit finance for property development. By exploring senior lending, bridging finance, mezzanine finance, true equity, and combined models, we aim to offer a comprehensive understanding of the financing avenues available. Although not all of these strategies qualify as traditional credit products, their inclusion paints a holistic picture of funding options for developers and investors. These strategies are examined alongside examples of UK-based firms to illustrate their practical applications. It is important to note that these examples are illustrative and not promotional.
Senior lending
Senior finance is a cornerstone of property development lending, representing the lowest-risk position in the capital structure due to its first-charge security on assets. This strategy is characterised by its priority claim over a project’s assets in the event of default, offering lenders and investors stability, predictability, and consistent cash flows. While the returns are modest compared to subordinated debt or equity investments, the conservative risk profile of senior finance continues to make it an appealing choice for institutional and risk-averse investors.
Typically, senior finance is utilised across a wide spectrum of project types, including residential, commercial, mixed-use developments, and infrastructure projects. Loan amounts vary significantly, catering to both small-to-medium projects (loans ranging from £1 million to £10 million) and medium-to-large developments (with loans ranging from £10 million to £100 million or more). In terms of risk mitigation, senior lenders typically cover up to 65% Loan-to-Value (LTV) or up to 80% Loan-to-Cost (LTC) of the project, ensuring that sufficient equity is invested by the developer to absorb potential losses.
For lenders and investors, the appeal of senior finance lies in its conservative approach to risk management, robust collateralisation, and clear exit strategies. The lower yield compared to subordinated debt or equity is balanced by the higher certainty of repayment and lower exposure to market volatility. The senior lending market has evolved in response to rising interest rates and growing demand for sustainable developments. Increasingly, lenders are emphasizing ESG (Environmental, Social, and Governance) principles, prioritising projects that promote energy efficiency, environmental sustainability, and social inclusivity.
Examples of senior lending firms:
● Federated Hermes
● BLG Development Finance
● Excellion Capital
Bridging finance
Bridging finance represents a key component of short-term property lending, appealing to lenders and investors due to its potential for medium returns, rapid capital turnover, and relatively low risk. While not traditionally classified as development credit, it plays a crucial role in the property finance ecosystem by enabling rapid access to capital. The primary purpose of bridging loans is to provide temporary funding that enables developers or property buyers to close transactions quickly, often ahead of securing more traditional, long-term financing arrangements. These loans typically have terms ranging from six to 18 months and are secured against tangible property assets, offering investors a degree of collateral-backed security.
From the investor’s perspective, bridging finance serves as an opportunity to achieve attractive returns within a compressed timeframe, as interest rates for these loans tend to exceed those of senior debt products. The short-term nature of bridging loans also allows for rapid reinvestment cycles, offering flexibility and liquidity.
The bridging finance market in the UK has experienced significant growth over the last decade, driven by increased demand for refurbishment projects, auction purchases, and gap-funding solutions for developers awaiting completion of long-term loans. As property markets in urban and suburban areas remain competitive, the demand for swift capital injections has risen. For investors, this trend underscores the importance of aligning with lenders who prioritise operational agility and sound due diligence.
Although bridging finance is generally low-risk due to its collateralised structure, lenders and investors must remain vigilant about market downturns or prolonged property sale cycles, as these can jeopardise the repayment timelines. Borrowers’ exit strategies — typically refinancing or property sales — are critical factors evaluated during loan underwriting to ensure a seamless return of capital.
Examples of bridging finance firms:
● Bridging Finance Solutions (BFS)
● MT Finance
● Roma Finance
Mezzanine finance
Mezzanine finance is a hybrid form of property development funding which occupies a subordinate position in the capital structure below senior debt but above equity. Its unique risk-reward profile makes it a compelling option for lenders and investors seeking enhanced yields. Mezzanine loans often feature equity-like components, such as warrants or profit participation, enabling investors to benefit from project success in addition to receiving interest income.
For lenders, mezzanine finance offers an opportunity to achieve higher returns than senior debt due to its higher risk exposure. This increased risk stems from its subordinated position, meaning repayment occurs only after senior debt obligations have been met. However, its inclusion in a project’s financing stack can diversify income streams and improve portfolio returns when paired with robust due diligence and structured agreements.
Mezzanine finance is predominantly utilised for medium- to large-scale property developments, such as residential, commercial, or mixed-use projects. It is particularly attractive in high-demand urban areas where constrained senior lending has created a funding gap. Developers often leverage mezzanine finance to cover the difference between senior debt and equity, enabling them to maintain equity stakes while securing additional capital for their projects.
The mezzanine lending market has grown significantly in recent years, driven by the increased demand for flexible funding solutions amid tightening senior lending conditions. Lenders have also refined their approaches to risk assessment, utilising detailed market analysis and emphasising projects with clear exit strategies and substantial equity contributions from developers.
Examples of mezzanine finance firms:
● Clearwell Capital
● Pluto Finance
● Iron Bridge Finance
True equity
True equity represents a form of property development funding where investors provide capital in exchange for an ownership stake in a project, rather than receiving fixed interest payments as in debt-based financing. While not a traditional credit product, equity plays a crucial role in enabling ambitious projects by filling funding gaps that debt solutions cannot address. This high-risk, high-reward strategy appeals to investors who seek significant upside potential and are willing to share in both the profits and the risks associated with property development.
From a lender’s and investor’s perspective, equity financing offers the potential for uncapped returns, which are directly tied to the project’s profitability. However, the lack of fixed repayment schedules and the subordinated position in the capital stack mean that equity investors stand to lose their entire investment if the project underperforms or fails. Unlike debt instruments, equity lacks collateralised security, making careful due diligence, project selection, and alignment with experienced developers paramount.
Equity financing is particularly attractive in markets with strong growth potential, where innovative or high-value developments are more likely to generate outsized returns. Investors often focus on projects with unique selling propositions, such as those in high-demand urban areas, regeneration zones, or markets with favourable demographic trends.
In the current property market, equity investors are gravitating toward mixed-use and regeneration projects that offer long-term value creation. The flexibility of equity financing makes it particularly suitable for projects with complex capital needs or unconventional business models, which may not align with the rigid criteria of debt-based funding.
Examples of true equity firms:
● Maven Capital Partners
● Apache Capital Partners
● Finbri
Combined model
The combined model represents an innovative approach that merges elements of mezzanine finance and equity funding. Like mezzanine finance, it typically holds a second charge on the property, offering lenders a level of security in the event of default. However, it also incorporates equity-like features, such as profit-sharing arrangements, which enable lenders to participate in the project’s upside potential. This unique combination allows the strategy to deliver higher returns than standalone mezzanine or equity finance.
One key feature of the combined model is the mechanisms lenders often use to reduce risks. These include establishing joint ventures with developers, enabling lenders to actively oversee project execution. By maintaining a degree of control throughout the development process, lenders can ensure milestones are met, costs are managed, and quality standards are maintained, thereby mitigating potential risks.
The dual structure of this model — interest income from the loan combined with profit sharing — makes it highly appealing to investors seeking a balance between risk and reward. The second charge on the property further provides a safety net, ensuring partial recovery of capital even in adverse scenarios. However, due diligence remains critical in this strategy, as lenders must carefully evaluate the developer’s expertise, market conditions, and the project’s feasibility before committing funds.
Examples of combined model firms:
InDome Capital: Offers loans up to £2.5 million with up to 98% LTC, employing its own proprietary IT solution to manage project risks. The company enters into joint ventures with developers, blending mezzanine finance features with equity participation. This enables it to secure a second charge on the property while also participating in project profits. By combining interest-based returns with profit-sharing, InDome delivers higher yields compared to traditional lending strategies. The firm caters to small-to-medium-sized developments, providing a flexible yet controlled funding.
The evolving landscape of property development finance in the UK offers a wealth of opportunities for both investors and developers. By diversifying into private credit strategies such as senior lending, bridging finance, mezzanine finance, true equity, and combined models, stakeholders can unlock tailored solutions that address varying risk appetites, project scales, and market conditions.
Among these strategies, the combined model stands out as particularly attractive. By blending the features of mezzanine finance and equity, this approach provides a compelling balance of risk and reward. The dual structure — offering interest income alongside profit-sharing — delivers enhanced returns while mitigating risks through second-charge security and stringent oversight mechanisms. For investors seeking to diversify their portfolios and capitalise on the growth opportunities in property development, the combined model represents a versatile and high-potential option. As the market continues to evolve, its innovative structure and adaptability are likely to further bolster its appeal.
Ultimately, successful navigation of these strategies hinges on robust due diligence, clear exit plans, and alignment with experienced financial partners. As private credit continues to gain prominence, understanding the nuances of these funding avenues will empower investors to optimise their outcomes while contributing to the growth and sustainability of the UK property market.
Sources:
- https://www.cambridgeassociates.com/en-eu/insight/private-credit-strategies-introduction
- https://www.morganstanley.com/ideas/private-credit-outlook-considerations
- https://www.investopedia.com/terms/m/mezzaninefinancing.asp
- https://www.ukfinance.org.uk
- https://www.hilltopcreditpartners.com/insights
This publication has been prepared by Elbrus Capital Partners LLP
Publishing date
5th February 2025
Language, English
Contact
www.elbruscp.com
