Deriving an acceptable profit is a key objective in any property development. A developer will generally assess a development profit based on the ratio between the gross realisation and the total costs of the project. Depending on the project, acceptable profits are usually in the order of 15% or higher. IMA acknowledges that development profit is an important tool in assessing a project. It is possible however, that developers overlook some projects because they have not assessed the return on equity.

Return on equity is an exceptionally important tool for the assessment of projects. Essentially, return on equity is the ratio between the development profit and the amount of equity required by the developer to complete the project.

As the example below indicates, a project with a $10 million end value may produce a development profit of 22%. Assuming traditional funding from a bank of 70% and a time frame of one year, the developer will be required to provide equity of 30% in order for the project to be financed. In this instance, the developer will generate a return on equity of 77%.

A 77% return on equity is entirely acceptable, however by utilising mezzanine finance, a significantly higher return can be achieved. The example below shows the same project with mezzanine funding substituting two thirds of the equity required by a traditional lender.

Although the interest rate on the mezzanine portion is higher than a traditional lender, the development profit after interest has only reduced to 17%.

The most significant difference however, is the return on equity. In the traditional funding scenario, the return on equity is 77%. With mezzanine funding, the return on equity increases to 191%.

In summary mezzanine funding can provide significant advantages to a developer including the following:

• Less equity required to participate in projects that a developer may otherwise have overlooked;
• Less equity required for each project, in turn increasing the financial capacity of a developer for other projects.