One line in the fund documents, three readings of it, and a cure that fails if the manager sells assets and keeps the equity.
Divide the fund's debt by the limit to get the lowest property value the limit allows, then compare it with today's value: headroom = 1 − debt ÷ (limit × property value) on the plainest definition. On an illustrative fund with 450 of debt against 1,000 of property and 50 of cash, a 50 per cent LTV limit is breached after a 10.0 per cent fall if LTV is gross debt over property, 15.0 per cent if cash is added to the denominator and 20.0 per cent if it is netted from debt. The definition in the fund documents doubles the headroom.
Worked in full in Real Estate Fund Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most closed-ended and open-ended real estate funds carry a fund-level leverage restriction in the LPA or prospectus, separate from the covenants in each loan. It is often a single line, "borrowings shall not exceed 50 per cent of gross asset value", and it is the one investors watch when values fall. Three things decide how much room it leaves: what counts as debt, what counts as value, and what the manager can actually do once it is breached.
| Item | Value |
|---|---|
| Property at valuation | 1,000 |
| Cash | 50 |
| Asset-level mortgages | 430 |
| Fund revolving credit facility, drawn | 20 |
| Total debt | 450 |
| Gross asset value (property plus cash) | 1,050 |
| NAV | 600 |
| Fund LTV limit | 50% |
How GAV becomes NAV, with the items that sit between them, is worked in how to get from GAV to NAV in a real estate fund.
(a) Gross debt ÷ property: breach when V = D ÷ L = 450 ÷ 0.5 = 900
(b) Gross debt ÷ GAV: breach when V + cash = D ÷ L, so V = 900 − 50 = 850
(c) Net debt ÷ property: breach when V = (D − cash) ÷ L = 400 ÷ 0.5 = 800
Headroom = 1 − breach value ÷ current value. In Excel for definition (a): =1-B6/(B9*B2), with property in B2, total debt in B6 and the limit in B9.
| Definition | LTV today | Breach value | Headroom |
|---|---|---|---|
| (a) Gross debt / property | 45.0% | 900 | 10.0% |
| (b) Gross debt / GAV | 42.9% | 850 | 15.0% |
| (c) Net debt / property | 40.0% | 800 | 20.0% |
The same balance sheet gives 10.0 per cent of headroom or twice that. Cash is the swing item: 50 of it is worth 5 points of value decline when counted as an asset and 10 points when netted from debt, because netting shrinks the numerator rather than growing the denominator.
| Value fall | Property | (a) | (b) | (c) | NAV | NAV change |
|---|---|---|---|---|---|---|
| 0% | 1,000 | 45.0% | 42.9% | 40.0% | 600 | 0.0% |
| 5% | 950 | 47.4% | 45.0% | 42.1% | 550 | −8.3% |
| 10% | 900 | 50.0% | 47.4% | 44.4% | 500 | −16.7% |
| 15% | 850 | 52.9% | 50.0% | 47.1% | 450 | −25.0% |
| 20% | 800 | 56.2% | 52.9% | 50.0% | 400 | −33.3% |
| 25% | 750 | 60.0% | 56.2% | 53.3% | 350 | −41.7% |
Property is 1.67 times NAV, so every point of value lost takes 1.67 points off NAV. By the time a fund on definition (a) is 2.9 points over its limit, investors have lost a quarter of their equity.
Take the 15 per cent fall under definition (a): property 850, LTV 52.9 per cent. The debt that must go is D − L × V = 450 − 425 = 25.0.
A sale only cures a fund-level limit if the equity it releases repays debt somewhere else. Managers who plan to "sell down to the limit" should check that the revolver and the other mortgages can be prepaid, and at what cost, before they need to.
Quoting headroom from the LTV in the quarterly report without checking the definition behind it. A report that nets cash (40.0 per cent here) against an LPA that tests gross debt over property (45.0 per cent) shows twice the room the LPA allows: 20.0 per cent of value instead of 10.0. Related loan-level arithmetic, where the cure is a cash deposit with the lender, is in how much cash cures an LTV covenant breach.
Read the definition, compute the breach value as debt over the limit (adjusted for cash), and plan the cure in debt repaid, not assets sold: 25.0 of debt here, or 50.0 of sales with every dollar applied to borrowings. Real Estate Fund Management treats leverage at fund and asset level as one system, and the free workbooks for the book include the debt sizing, covenant and refinancing model.
Each fund sets its own in the LPA or prospectus, usually tighter for core strategies than for value-add or opportunistic ones; this example uses an illustrative 50 per cent. What matters as much as the level is the definition: on the same balance sheet here, 50 per cent leaves 10.0, 15.0 or 20.0 per cent of value headroom.
It depends on the documents. Counted in gross asset value, 50 of cash moves the breach value from 900 to 850. Netted from debt, it moves it to 800, because netting reduces the numerator. Always read the definition before quoting headroom.
Only if the equity released repays debt. Selling 100 of property at a 15 per cent value fall and keeping the 49.4 of equity lifts gross LTV from 52.9 to 53.3 per cent. Applying all 100 to debt takes it to 46.7 per cent; 50.0 of sales applied to debt is enough to reach 50.0 per cent.
This article is one calculation from Real Estate Fund Management. 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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