Financing innovation for real estate companies in my country - mezzanine financing

1. About mezzanine financing

(1) The concept of mezzanine financing

Mezzanine Mezzanine Financing is a financing method between senior debt and equity. It refers to the process by which enterprises or projects raise funds through mezzanine capital. The reason why it is called mezzanine is that from the perspective of capital costs, the financing costs of mezzanine financing are lower than equity financing. For example, the fixed interest rate of debt can be adopted, which reflects the advantages of debt to equity holders; from the perspective of equity, the equity of mezzanine financing is low For priority creditors, it can reflect the advantages of equity. In this way, an additional layer is added to the traditional binary structure of equity and bonds. Mezzanine financing is a very flexible financing method that serves as a buffer between equity and debt, improving capital efficiency.

Mezzanine financing models are roughly divided into four types. The first is the equity repurchase type, which is to invest the raised funds into the equity of the real estate company and then repurchase it. This is relatively low-level. The second is that the real estate company provides loans on the one hand, and on the other hand gives part of the equity and equity beneficial rights to the trust company, which is the "loan + trust company + equity pledge" model. The third type is a loan plus stock options, with the loan being repaid as a senior bond upon maturity. The fourth model is multi-layer innovation.

(2) Risks and rewards of mezzanine financing

The returns of mezzanine financing are usually obtained from one or more of the following sources: 1. Cash coupon, usually a higher than A floating interest rate based on the relevant interbank interest rate; 2. Repayment premium; 3. Equity incentive, which is like a warrant that the holder can redeem by exercising the warrant when the equity is sold or issued. The interest rate level of mezzanine financing is generally 10% to 15%, and the target return rate of investors is 20% to 30%. Its return rate is lower than private equity and higher than senior debt; its risk is lower than equity financing and higher than senior debt. Generally speaking, the lower the mezzanine interest rate, the more equity subscription rights there are.

(3) Forms of mezzanine financing

Mezzanine financing usually takes the form of mezzanine bonds, preferred shares, or a combination of both. It can also take the form of subordinated loans or convertible notes. form. In mezzanine debt, investors lend funds to the borrower's parent company or some other high-level entity that owns shares of the borrower (hereinafter referred to as the "mezzanine borrower"). The mezzanine borrower transfers its equity interest in the actual borrower's shares. At the same time, the parent company of the mezzanine borrower also pledges all its unlimited partner shares to the mezzanine investors. In this way, the mortgage equity will include the borrower's income distribution rights, thereby ensuring that when a default is repaid, mezzanine investors can be repaid prior to equity holders, using a structural approach to place the interests of mezzanine investors above common equity and below bonds. . In a preferred stock structure, mezzanine investors exchange funds for preferred stock interests in the actual borrower. The priority of mezzanine investors is reflected in receiving dividends before other partners. In the event of default, the preferred partner has the power to control all partnership interests in the borrower (see Figure 1).

(4) Characteristics of mezzanine financing

First, mezzanine financing combines the characteristics of fixed income capital and the characteristics of equity capital, and can obtain dual benefits of cash income and capital appreciation.

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Secondly, for investors, mezzanine financing has certain Predictable, stable, positive cash inflow, and the ability to change the capital structure through financial leverage to increase investment returns.

Third, for financiers, mezzanine financing costs are generally higher than senior debt but lower than equity financing, and financing terms can be designed according to the unique needs of customers to minimize control over the company. of dilution. Mezzanine financing is suitable for companies or projects whose cash flow can meet the repayment of principal and interest on existing senior debt, but it is difficult to afford more senior debt.

Fifth, from an industry perspective, mezzanine financing is mainly used in infrastructure and industrial and commercial projects due to requirements on financing scale, cash flow and credit rating.

Sixth, the shortcomings of mezzanine financing are that the products are non-standardized, information transparency is low, the legal structure is complex, and its costs are much higher than mortgage loans. In addition, borrowers must obtain consent from mortgage investors when considering mezzanine financing.

2. Analysis of demand for real estate mezzanine financing in my country

At this stage, real estate companies in my country have little room for financing options. First, the threshold for equity financing is too high. Among the more than 30,000 real estate companies across the country, the vast majority are small and medium-sized enterprises. They cannot meet the basic requirements for listing, but their demand for funds is more urgent. Second, the scale of financing for listing is limited. As of early 2004, only more than 60 real estate companies across the country had achieved direct financing from the securities market; third, the lack of industrial fund legislation has made the financing method of real estate funds temporarily unfeasible.

Overall, my country's economy is operating well and the reform of the financial system continues to deepen, creating a stable environment for the innovation of real estate financing channels. Diversifying real estate financing methods is conducive to the development of the real estate market and the real estate industry.

The income of urban and rural residents continues to grow, and there is broad space for financing in the domestic capital market. Since mezzanine financing has no capital investment restrictions and allows small and medium-sized investors to enter, it can provide an opportunity for urban and rural residents in my country to invest in real estate. According to data from the 2006 Statistical Yearbook, the savings of urban and rural residents in my country are increasing year by year, with huge investment potential (Figure 2).

In short, changes in the macro legal environment and cautious bank lending have led to a shortage of funds in the real estate industry, and real estate development companies need to turn to other financing channels. At this time, mezzanine financing has become another important source of funds for real estate development companies, with some inevitability.

3. Ways to realize the use of mezzanine financing in real estate financing in my country

(1) Selection of carriers for the introduction of mezzanine financing

The investment method of foreign mezzanine financing is first established A mezzanine investment fund, and then select suitable projects for investment. Different from China's traditional financing process, mezzanine funds generally raise funds first, and then look for investment projects with matching returns and risks based on the funds. Since there is no industrial fund law in China and the fund market and securities market are not perfect, it is unlikely to directly establish a mezzanine investment fund for real estate investment. Mezzanine financing requires choosing a suitable carrier to enter the industrial market.

Under my country's current financial system environment, there are many obstacles for commercial banks to carry out mezzanine financing innovation on a large scale. The first is the problem of insufficient funds. Mezzanine capital is a high-risk asset class and requires a large amount of capital. This is a big difficulty for commercial banks that generally have insufficient capital adequacy ratios. Secondly, the design, management and risk control of mezzanine financing products are very different from the traditional business of banks, and commercial banks currently lack the corresponding technology and experience. In addition, Article 43 of the Commercial Banking Law also stipulates that domestic commercial banks cannot invest in non-bank financial institutions and enterprises. Therefore, commercial banks cannot yet become the carrier for introducing mezzanine financing.

The author believes that the best carrier to introduce mezzanine financing in the real estate market is a trust company. American trust expert Scott believes that “the scope of application of the trust industry is comparable to human imagination.” Trusts have three core functions: property isolation, avoidance of policy obstacles and reasonable tax avoidance. In our country, trust companies are the only financial institutions that link the money market, capital market, and industrial market. Trust companies can invest in real estate, so currently only trust companies in China can better use mezzanine financing to solve the financing problems of real estate companies in my country.

On the one hand, trusts have unique institutional advantages, broad space for innovation, and huge flexibility. Trust products can flexibly and fully adapt to and handle various economic and legal relationships in real estate, solving problems that are difficult to solve through other channels. The real estate trust financing method can not only reduce the overall operating costs of the real estate industry and save financial expenses, but is also very flexible in terms of supply methods. It can design personalized fund trust products according to the real estate company's own operational needs and specific projects, thereby increasing market supply and demand. Choice space for both parties.

On the other hand, because the original real estate policy has greatly raised the threshold for trust loans, it is still very limited in solving the financing problems of long-term, large-scale projects. By introducing mezzanine financing, a new financing method, trust companies can expand their business, optimize their investment structure, improve their market competitiveness and influence, and also play an important role in expanding their sources of profits.

Finally, trust companies already have rich practical experience in investing in the real estate industry. Among all the businesses of trust companies, real estate trust has become one-third of the world. Real estate trust business has become a trust company. A very important source of profit.

(2) Mezzanine financing structure selection

Combined with the characteristics of real estate development, this article proposes the following mezzanine financing investment and repayment structure arrangements:

1. Arrangements for investment in the mezzanine investment stage

For real estate trusts, the most critical issue at present is to provide financing to developers before the developer's "four certificates" are complete, otherwise real estate trusts have no meaning. When the project is in the development stage and there is no need to apply for loans from banks and trust companies, funds can be entered through limited shares or convertible bonds as "mezzanine financing" to supplement the company's capital and provide superior bonds and banks with Loan entry offers conditions. For example, a real estate project requires the developer's own capital ratio to reach 35%. If the developer's own capital ratio is only 20%, "mezzanine financing" can inject funds in the form of equity participation, making the entire project fully funded. Reaching the required 35% will not affect the real estate developer’s controlling interest.

For projects that have already obtained bank loans but are facing a temporary shortage of funds in the early stages of sales, mezzanine financing can be arranged with a structure that is mainly debt investment and combined with a part of warrants, so that investors can obtain a certain amount of interest income and repayment premium.

Mezzanine investment can be a one-time investment or investment in installments. For example, part of the mezzanine investment can be arranged to inject development funds into the company's early investment; the other batch of funds can be invested when the company actually enters the project implementation stage. The purpose of this is to ensure the continuity of corporate capital supply and then determine the return on investment based on the investment risks at different stages.

2. Mezzanine financing repayment period arrangement

Mezzanine financing can adopt flexible repayment methods. For projects in the development stage, you can only be required to bear a certain amount of interest or not repay the principal and interest. The principal and a certain proportion of the project income will be repaid after the project has cash inflow. Because mezzanine investors generally do not seek control or long-term holdings, after the company has cash inflows, they usually take the form of selling income warrants or repurchasing preferred shares to obtain a certain investment premium, thereby realizing the exit of capital.

3. Mezzanine financing repayment interest rate arrangement

In terms of interest rate arrangements, the author believes that market-oriented principles can be adopted and flexible rates can be formulated and implemented in accordance with the principles of high risk and high return. The interest rate standard, that is, the interest rate of mezzanine investment is adjusted based on the developer's credit, self-owned capital ratio, investment period and other factors to ensure that risks and returns are equal.

4. Other special models that can be used for mezzanine financing

Mezzanine investment funds can adopt a trust model with the right of first refusal through a trust company, giving mezzanine investors priority to purchase completed properties. Rights, this investment model is very consistent with my country's national conditions. Under this structural arrangement, it not only solves the financing difficulties of real estate companies, but also solves the sales problems of real estate developers. Mezzanine investors can not only enjoy interest income during the development period, but can also choose to use the final purchase of real estate as a capital exit channel.

IV. Entry conditions for mezzanine financing

(1) The conditions that real estate companies that obtain mezzanine investment should meet

First, they must have the authorization of the company’s legal person or the signature of the board of directors The approved application report; the second is that a basic account or general deposit account has been opened; the third is that true and comprehensive (audited) financial statements and reports are provided, and its financial indicators and asset-liability ratio meet the loan requirements; the fourth is that in addition to In addition to the provisions of the State Council, there are certain requirements for the various capital ratios of enterprises that obtain mezzanine financing, such as the ratio of mezzanine financing to the company's own funds, the ratio of mezzanine financing to priority debt, the ratio of mezzanine financing to the investment project. Proportion of total investment required, etc.

(2) Conditions that projects that obtain mezzanine financing should meet

First, the investment project has been demonstrated through feasibility studies and can effectively meet the needs of the local housing development market and has good market prospects. ; Second, the investment project has been included in the national or local real estate development and construction plan, and its project approval documents are complete, authentic, and valid, and can be substantively developed; Third, the investment project budget and construction plan comply with the relevant regulations of the state and local governments: Fourth, the total engineering budget investment of the investment project can meet the need for additional budget due to inflation and unforeseen reasons before the completion of the project; fifth, the infrastructure and public facilities construction supporting facilities of the investment project can be provided in a timely manner after the project is completed. Put into normal use.

5. Mezzanine financing exit mechanism selection

Compared with separate equity financing, mezzanine financing has certain advantages in the exit of funds. A predetermined repayment schedule is usually included in the mezzanine investment debt structure, and the debt can be repaid in installments over a period of time or in a lump sum. The repayment pattern will depend on the cash flow profile of the target company for the mezzanine investment. Therefore, mezzanine investment provides a clearer exit path than private equity investment (the latter generally relies on liquidation with greater uncertainty). At the same time, when mezzanine financing takes the form of preferred stocks or convertible bonds, it can also be repurchased by developers or management, or sold to institutional investors who are willing to hold for a long time until maturity and investors who are willing to hold shares in real estate companies. , to earn the price difference.

For example, when arranging product flexibility, Lianxin Baoli No. 7 drew on the market maker system of futures trading and introduced investment institutions to act as "market makers". Before the trust plan is issued, it is agreed that the holders of the trust plan's priority beneficial rights products will be sold to the market maker at the agreed price one year after the expiration of the trust plan. The market maker can sell the trust plan to earn the price difference, or it can The trust plan holds and earns income upon maturity. This approach improves the liquidity of mezzanine financing products and can also be used as a reference for the mezzanine financing exit system.