Commercial real estate acquisitions are routinely financed with a combination of equity and mortgage debt. The financing structure in each direct-hold limited partnership is designed around two constraints: the loan-to-value limit set by the lender, and the debt service coverage ratio floor established as a covenant in the partnership's governing agreement. These two constraints determine the maximum mortgage quantum for a given asset, the interest obligation that the ICR distribution gate must clear, and the interest rate risk profile of the investment.

Key takeaways

• The mortgage debt in each direct-hold LP is secured against that LP's specific property; lenders have no recourse to the properties of other LPs or to the equity of the parent holding company absent specific guarantees.
• Debt size is constrained by two independent tests: the lender's loan-to-value (LTV) limit (typically 60–75% of appraised value for commercial properties) and the 1.2× ICR floor, which limits total interest to no more than 83.3% of stabilised NOI.
• Fixed-rate mortgage debt reduces income statement volatility during the fixed term but creates refinancing exposure at maturity; floating-rate or variable-rate debt creates immediate income sensitivity to benchmark rate changes.

Loan-to-value constraint

Commercial mortgage lenders set a maximum loan as a percentage of the property's appraised value. The standard range for income-producing commercial property in Canadian institutional markets is 60% to 75% LTV, with lower leverage permitted for trophy assets or fully leased long-term-covenanted tenancies, and higher leverage occasionally available under government- backed programs for specific asset types.

At 65% LTV, a property appraised at $10,000,000 supports a mortgage of $6,500,000. The remaining $3,500,000 of value must be funded with equity from the LP unit holders. The LTV ratio is assessed at origination and may be tested again at refinancing or covenant review dates.

DSCR-constrained debt sizing

The debt service coverage ratio (DSCR) is the second independent constraint on mortgage size. The DSCR is NOI divided by annual debt service (principal and interest). Institutional lenders in Canada typically require DSCR of 1.20× to 1.30× at origination for commercial mortgages.

The 1.2× ICR floor, established as a covenant in the partnership's governing agreement, aligns with the typical lender DSCR minimum. At a 1.2× ICR and stabilised NOI of $600,000, the maximum permissible interest obligation is $500,000 per year (NOI ÷ 1.2). At an assumed interest rate of 5.0%, this constrains the mortgage principal to $10,000,000. If the LTV test allows only $7,500,000 (at 75% of $10,000,000 appraised value), the more restrictive of the two constraints governs.

In practice, the binding constraint varies by asset: properties with thin NOI relative to value (low NOI yield) are LTV-constrained; properties with strong NOI but conservative lender valuations may be DSCR-constrained.

Amortisation and interest-only periods

Commercial mortgages are structured with varying combinations of principal amortisation and interest-only periods. An interest-only loan requires no principal repayment during its term; on maturity, the full original principal is due (a "bullet" repayment). An amortising loan requires scheduled principal repayment during the term, reducing the outstanding balance over time and building equity in the property through debt paydown.

Interest-only periods — common in commercial real estate at origination — reduce the annual cash outflow during stabilisation or lease-up phases, when occupancy is building toward stabilised levels and NOI may not yet fully support amortising debt service. When the property reaches stabilised occupancy, the mortgage terms typically shift to amortising; the higher cash requirement of the amortising schedule is accommodated by the higher stabilised NOI.

The direct-hold LP's ICR calculation uses total interest obligations, not total debt service (principal plus interest). An interest-only mortgage with a given interest cost produces the same ICR test result as an amortising mortgage with the same interest rate and a lower outstanding principal; the principal repayment portion of a fully amortising mortgage is not included in the denominator of the ICR test.

Interest rate risk

The interest rate on a commercial mortgage can be fixed for the term or floating based on a benchmark rate (such as the Canadian Overnight Repo Rate Average — CORRA — plus a credit spread). Fixed-rate mortgages protect the LP from interest rate increases during the term and lock in a predictable debt service cost. At maturity, the mortgage must be refinanced at the then-current market rate, which may be materially higher or lower than the original rate.

Floating-rate mortgages expose the LP to immediate changes in debt service cost as benchmark rates move. An upward movement in benchmark rates increases interest expense and reduces the ICR, potentially triggering the distribution suspension protocol if the rate increase is sufficient to breach the 1.2× floor.

The partnership does not hedge interest rate risk at the entity level as a standing policy; hedging decisions — interest rate caps, swaps — are made in connection with specific mortgage transactions based on the risk profile of the relevant asset and market conditions at the time.

Refinancing risk

At mortgage maturity, the LP must either repay the outstanding principal or refinance with a new mortgage. Refinancing risk arises when credit conditions, property values, or lender appetite have deteriorated since the original financing: the available mortgage quantum may be lower (due to LTV compression or DSCR deterioration), and the interest rate may be higher. If the available refinancing proceeds are insufficient to repay the maturing mortgage, the LP must inject equity capital from its unit holders or sell the asset to repay the lender.

This refinancing risk is a structural feature of time-limited mortgage financing and is not specific to direct-hold structures; it applies to all commercially financed real estate assets.

See also

• distribution-declaration-mechanics — how the ICR constraint interacts with the distribution declaration process
• asset-vehicle-isolation — how mortgage creditors are limited to the asset of the LP in which they lend