Why debt-free property ownership matters in a downturn

How leverage works

Buy a £2 million building with £1 million of your own money and £1 million borrowed. If the building rises in value to £2.4 million, your equity has gone from £1 million to £1.4 million, a 40% gain on a 20% rise. That is the appeal, and it is real.

Now run it the other way. The building falls to £1.6 million. Your equity has gone from £1 million to £600,000, a 40% loss on a 20% fall. Same mechanism.

Two risks that do not cut both ways

The arithmetic above is symmetrical. What follows is not.

Loan covenants. Commercial property loans come with conditions, usually a maximum loan-to-value ratio and a minimum interest cover ratio. A fall in valuation can breach the loan-to-value covenant even when every tenant is paying on time. A breach gives the lender rights: to demand repayment, to require more capital, or in the end to enforce its security and sell.

That deserves a moment's thought. The building is fully let, the rent is being paid, nothing about the asset has changed, and the lender can still force a sale because a valuer's opinion has moved.

Refinancing. Loans have terms. When the term ends, the debt has to be repaid or refinanced. If credit has tightened, or values have fallen, or interest rates have risen, refinancing may be available only on worse terms, or not at all. The borrower then has to sell, into a market where everyone else in the same position is also selling.

This is how investors actually lose money

Property does not usually ruin investors by falling in value, because values recover. It ruins them by forcing a sale at the bottom, which turns a paper loss into a permanent one.

That needs a lender. Take away the borrowing and you take away the mechanism. An investor with no debt in a downturn owns a building worth less than it was, and can wait.

Helmsley has bought every one of its syndicated buildings with cash, without bank debt, since we began. We have owned property through the early 1990s, 2008 and the pandemic, and not having a lender in the room during any of those periods is the single decision we are most glad of.

Income behaves differently as well

Interest is a fixed cost paid before investors. If rent falls by 20% in a geared structure where interest takes half the rent, the distribution does not fall by 20%; it falls by 40%. If rent falls far enough, the distribution disappears while the interest is still being paid.

Without borrowing, a 20% fall in rent produces roughly a 20% fall in the distribution. Unwelcome, but proportionate, and it does not put ownership of the building at risk.

The trade-off, honestly

Owning without debt is not free.

You give up the amplification. In a strong rising market a geared investor makes more, and over a long enough stretch with no crisis, leverage wins on paper.

You need more capital for the same exposure. £1 million buys one ungeared building or shares in two geared ones.

And it removes only one category of risk. A debt-free building with a failed tenant produces no income. A debt-free building in a poor location still falls in value. Debt-free is not low risk. It is one particular risk taken away, and it happens to be the one that turns bad years into permanent losses.

The question to ask

Of any property investment, ask whether it borrows, how much, when the debt matures, what the covenants are, and what happens if they are breached.

If borrowing is used, that is not disqualifying in itself. Plenty of well-run geared investments exist. But you should be able to answer those questions before you commit, because they decide what happens in the bad years rather than the good ones.

Take independent advice.

How we approach this at Helmsley →