Debt service and financing structure

External mortgage debt is not how the Direct-Hold Solutions are financed. This article describes the general conventions of commercial-mortgage financing: the loan-to-value limit a lender sets, amortisation and interest-only terms, interest-rate exposure, and refinancing risk. It then shows how each interacts with the 1.20× Interest Coverage Ratio (ICR) floor established as a covenant in each direct-hold limited partnership's governing agreement. It is market background, not a description of the vehicles' own capital structure. For that — equity-funded unlevered construction, followed by First Secured Mortgage Debentures planned to be issued by the vehicle itself rather than borrowed from an external lender — see the Narrow Bank Financial Model.

Key takeaways

• In a conventional commercial mortgage, debt is secured against a specific property; the lender has no recourse to other assets or to the equity of a parent holding company absent specific guarantees.
• Mortgage size is constrained by the lender's loan-to-value (LTV) limit. The 1.20× ICR floor is a separate and independent constraint, established as a covenant in the partnership's governing agreement rather than imposed by a lender.
• 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. Under a 65% LTV limit, for example, the mortgage covers 65% of appraised value; the remaining 35% must be funded with equity from the borrower's own capital, whatever the property's appraised amount. The LTV ratio is assessed at origination and may be tested again at refinancing or covenant review dates.

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 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. The distinction matters wherever the covenant is applied, whatever the instrument being tested.

Interest rate risk

The interest rate on a commercial mortgage can be fixed for the term or floating based on a benchmark rate plus a credit spread. Fixed-rate mortgages protect the borrower 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 borrower to immediate changes in debt service cost as benchmark rates move. An upward movement in benchmark rates increases interest expense and reduces the ICR. Where an ICR covenant applies, a sufficiently large rate increase can constrain the capacity to issue further secured debt by pushing coverage toward the 1.20× floor.

Refinancing risk

At mortgage maturity, a borrower 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 a decline in coverage), and the interest rate may be higher.

Where refinancing proceeds fall short of the maturing principal, a conventionally financed borrower must meet the difference from another source — additional equity from its sponsors, or a sale of the asset. That exposure belongs to external mortgage financing, not to the direct-hold vehicles: under the Narrow Bank Financial Model, unit holders cannot be required to contribute additional capital to cover debt obligations.

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

• Narrow bank financial model — the Direct-Hold Solutions' own planned two-phase financing, which does not use external mortgage lenders
• 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