Although back leverage is still a relatively new concept in commercial real estate financing, it has already established itself as a staple in some markets. US and British investors in particular use this instrument to manage capital structures more flexibly and thus achieve double-digit target returns. In their investment decisions, they are strongly oriented towards real estate cycles and have no reservations about complex financing structures.
In countries such as the US or the UK, real estate debt structures are often managed by experienced asset managers or debt advisors. It is common to bundle investments in portfolios, set them up institutionally and include alternative lenders such as private debt funds.
This trend seems to meet with broad approval. According to a recent survey by Knight Frank Capital Advisory, 90% of respondents believe that back leverage is either already the market standard in commercial real estate markets or will be in the near future.
In Germany, traditional financing structures dominate
In Germany, the situation is completely different: Institutional investors often prefer first-class collateralisation in order to be able to control the financing and ultimately the property at all times. More complex financing is often viewed with scepticism, which is also due to bad experiences with mezzanine or structured products as a result of the financial market crisis. In addition, there are regulatory hurdles, low trust in real estate private debt as an integral part of a strategic allocation or little experience with IRR-oriented risk models.
To better understand the potential, it is worth taking a look at how it works. Back leverage is a strategy in which a loan fund raises debt to increase its investments or reduce its effective equity investment. This means that the fund borrows additional money in order to be able to grant more loans in total. This allows the return potential to be significantly increased because a larger volume of capital can be used than with non-leveraged loans.
The liquidity released can be used in a variety of ways, e.g. to finance new projects, stabilize distributions or optimize the capital structure. At its core, it is a “loan-on-loan” structure, i.e. the borrowing of debt capital on a loan that has already been granted.
The concept can be compared to a combination of whole loan and mezzanine financing. However, the main difference is that control remains with the original investor, although he slips economically into a subordinated position, comparable to that of a mezzanine financier. For experienced investors, the structuring of their loan portfolios thus offers an effective lever to tap into additional return potential depending on the market phase.
Advantages outweigh the disadvantages when implemented professionally
If you use back leverage correctly after a thorough risk analysis, you can secure some advantages. These include higher returns, efficient use of capital, scaling investments, and competitive advantage through potentially larger deals.
However, back leverage also comes with challenges. The total leverage ratio is increasing, and thus the requirements for the stability of cash flow are increasing. In addition, a high degree of financial expertise is an absolute prerequisite for the successful use of this instrument.
Back leverage can therefore not be a mass product, but an instrument for professional investors with resilient portfolios and clear governance. However, it is precisely these investors who could achieve returns of 12-13% in the current market situation with a well-diversified loan portfolio if they are willing to deal with the complex structure and a corresponding risk analysis.
Bottom Line: The Time for Back Leverage Is Now
The current market phase offers a rare opportunity for institutional investors. German banks continue to act cautiously and can usually only offer a loan-to-value ratio of 50 to 60%. International lenders are increasingly interested in entering the German market and the current valuation corrections are opening up new entry opportunities. Those who rely on back leverage now can tap into additional sources of return. Institutional investors in Germany should therefore actively look into this financing option. Otherwise, they could miss the boat on international market standards.
