Mortgage lending value worked from rent to capital value, bridged step by step to market value, and what lending 60 per cent of it means when the market falls.
Mortgage lending value (MLV) capitalises a sustainable rent, after full deductions for management, maintenance and letting risk, at a prudent long-term capitalisation rate; market value capitalises today's income at today's yield. On an illustrative office worth 41,263,158 at market, the MLV is 29,600,000, or 71.7 per cent. A lender that keeps loans within 60 per cent of MLV is lending 43.0 per cent of market value, and the property can fall 57.0 per cent before that loan is uncovered.
Worked in full in Real Estate Finance by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
MLV is a German concept with a wider reach: Pfandbrief banks may only put a mortgage into the cover pool up to 60 per cent of it, and European capital rules recognise it as a basis for property collateral. It answers a different question from market value. Market value asks what a buyer would pay today; MLV asks what the building can be relied on to fetch across a cycle, which is the question a lender actually has.
| Input | Market value | Mortgage lending value |
|---|---|---|
| Rent capitalised | 2,000,000 passing | 1,850,000 sustainable |
| Non-recoverable costs | 2% | 12% |
| of which management / maintenance / rent loss | 3% / 5% / 4% | |
| Yield or capitalisation rate | 4.75% | 5.50% |
| Bank's loan, as a share of market value | 65% | |
| Cover pool limit, as a share of MLV | 60% |
Step 1: market value. Passing rent less the small non-recoverable costs of a fully let building, capitalised at the market yield.
NOI = 2,000,000 × (1 − 2%) = 1,960,000
MV = 1,960,000 ÷ 4.75% = 41,263,158
Step 2: the sustainable rent. MLV uses the lower of the passing rent and a rent the valuer believes can be achieved over the long term, after stripping out cyclical peaks. Here that is 1,850,000.
Step 3: full deductions. Even where leases pass costs to the tenant, MLV deducts what the owner would bear over a cycle: management 55,500, maintenance 92,500 and a rent-loss allowance for voids and arrears of 74,000.
Deductions = 1,850,000 × 12% = 222,000
Sustainable NOI = 1,850,000 − 222,000 = 1,628,000
Step 4: the capitalisation rate. A long-run rate, set above current market yields and subject to a regulatory floor. In Germany the Beleihungswertermittlungsverordnung (BelWertV) resets that floor from the 30-year Bund yield, within a band of 4.5 to 6.5 per cent for commercial use, with surcharges for some property types and a reduction of at most 0.5 points for prime offices.
MLV = 1,628,000 ÷ 5.50% = 29,600,000
MLV ÷ MV = 29,600,000 ÷ 41,263,158 = 71.7%
Excel: =MIN(passing,sustainable)*(1-deductions)/cap_rate
| Step | Effect | Share of gap |
|---|---|---|
| Market value | 41,263,158 | |
| Rent: passing to sustainable, at the market yield | −3,094,737 | 26.5% |
| Costs: 12% instead of 2%, at the market yield | −3,894,737 | 33.4% |
| Yield: 4.75% to 5.50% on the sustainable NOI | −4,673,684 | 40.1% |
| Mortgage lending value | 29,600,000 |
The capitalisation rate does the most work, but not most of it: the deductions and the rent assumption together account for 59.9 per cent of the gap. A valuer who argues only about the cap rate is arguing about less than half of the difference.
What it does to the loan. The bank lends 65 per cent of market value, 26,821,053. Only 17,760,000, 60 per cent of MLV, can go into the cover pool; the other 9,061,053, or 33.8 per cent of the loan, has to be funded another way. Measured against MLV the loan is 90.6 per cent.
| Fall in MV | Market value | Cover loan / MV | Bank loan / MV |
|---|---|---|---|
| 0% | 41,263,158 | 43.0% | 65.0% |
| 10% | 37,136,842 | 47.8% | 72.2% |
| 20% | 33,010,526 | 53.8% | 81.2% |
| 25% | 30,947,368 | 57.4% | 86.7% |
This is the point of the method. A 28.3 per cent fall in market value only brings it down to the MLV, and the loan sized on MLV stays below 58 per cent LTV through a 25 per cent fall, while the loan sized on market value is at 86.7 per cent. Beyond that point the MLV itself is cut: under section 16(2) of the Pfandbrief Act it may never exceed market value. At a 30 per cent fall, to 28,884,211, the MLV drops to that figure and the cover-eligible amount to 17,330,526, so 429,474 has to leave the cover pool.
The MLV itself depends on two judgements, and the range is wide:
| Cap rate | Deductions 8% | 12% | 16% |
|---|---|---|---|
| 5.0% | 82.5% | 78.9% | 75.3% |
| 5.5% | 75.0% | 71.7% | 68.5% |
| 6.0% | 68.7% | 65.8% | 62.8% |
| 6.5% | 63.5% | 60.7% | 57.9% |
Reading MLV as a discount to market value, a fixed haircut of 20 or 30 per cent. It is not: it is a separate valuation with its own rent, costs and rate, and its ratio to market value moves with the cycle. When market yields are low the gap is wide, as here; after a correction market value can fall to the MLV, which then moves down with it, because the MLV may not exceed market value. A lender that applies a fixed haircut to market value lends the most at the top of the market, which is exactly what the method exists to prevent.
The second mistake is the over-rent. Capitalising a passing rent above the sustainable one at a market yield puts 3,094,737 into the market value that the lender cannot rely on when the lease ends.
The book's opening chapters put four values on one building and show which number a lender should use; the free workbooks for the case price each adjustment of that bridge on its own switch. For the market-value ratio a loan can be refinanced at, see what is a good LTV for commercial real estate.
Market value is the price a buyer would pay today; mortgage lending value is the value a lender can rely on over the life of the loan. In the example, market value capitalises 1,960,000 of NOI at 4.75 per cent to 41,263,158, while MLV capitalises a sustainable 1,628,000 at 5.50 per cent to 29,600,000.
Because the cover pool must stay safe through a downturn, so the limit is set against a value that already excludes cyclical peaks. On the illustrative office, 60 per cent of MLV is 17,760,000, which is 43.0 per cent of market value. Market value would have to fall 57.0 per cent before that portion of the loan was uncovered.
No. Under the German Pfandbrief Act the MLV may not exceed market value, so after a sharp correction it is cut to the market value. In the example, a 30 per cent fall takes market value from 41,263,158 to 28,884,211, below the 29,600,000 MLV; the MLV drops to 28,884,211 and the cover-eligible part of the loan from 17,760,000 to 17,330,526.
This article is one calculation from Real Estate Finance. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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