Leverage in Swiss Real Estate Funds and the One-Third Rule

Key Takeaways

What leverage is: a real estate fund borrows, by mortgaging its buildings, to hold more property than its equity alone would allow. As long as the rental yield exceeds the cost of the debt, borrowing amplifies the return on equity – and, symmetrically, the losses.
The one-third rule: Swiss law caps this borrowing. On average, all of a fund's buildings may be mortgaged only up to one third of their market value (art. 96 para. 1 CISO). This is a structural limit, not a market figure.
The framed exception: to preserve liquidity, this cap may be raised temporarily and exceptionally to one half of market value, if the fund rules allow it and investors' interests remain protected (art. 96 para. 1bis CISO) – under the audit firm's review.
The amplification: leverage multiplies the swings in net asset value. With 30% of debt, a 10% rise or fall in the value of the buildings moves the NAV by about 14% – in both directions.
The denominator trap: when the value of the buildings falls, the debt ratio rises mechanically, without a single franc being borrowed. A fund can thus approach the legal cap in the middle of a decline – which explains some capital increases.
Key reflex: read a fund's actual debt ratio against the legal limit, and remember that a comfortable ratio in good times can tighten quickly when valuations turn.

Introduction

A real estate fund almost never buys its buildings with equity alone. Like a private individual financing a home, it borrows – by pledging the buildings it holds – to acquire more. This use of debt, leverage, is at the heart of listed real estate funds' performance, and yet one of their least well understood mechanisms.

Leverage has a virtue and a danger, inseparable: it amplifies. As long as the rents earn more than the debt costs, it inflates the return on equity; the day the value of the buildings falls, it deepens the loss in the same proportion. It is precisely because this amplification can become dangerous that the Swiss legislator bounded it with a simple, old rule: the one-third rule.

This article describes what leverage really does to a real estate fund, what the law allows, and why an apparently controlled level of debt can tighten sharply when valuations turn. The numbers used are fictional and serve to illustrate a timeless mechanism. It extends our article on net asset value, whose logic it takes up to show how debt amplifies its movements.

What Leverage Does to Return

The economic principle of leverage comes down to a comparison of rates. An investment property earns a net rent, expressed as a percentage of its value. If that yield exceeds the rate at which the fund borrows, each franc borrowed and invested in bricks and mortar generates an extra return that goes not to the bank, but to the unitholders.

The effect is mechanical: the more the fund borrows, the more it captures this gap between rental yield and cost of debt, and the higher the return on its equity. That is why leverage is used, and why it was used particularly heavily when the cost of debt was low.

But the gap can close, or even reverse. If the cost of borrowing catches up with or exceeds the rental yield, leverage stops adding return and starts subtracting it. Leverage is therefore not an unconditional benefit: it is a bet on the persistence of a favorable gap between what the buildings earn and what the debt financing them costs.

The One-Third Rule: What the Law Allows

Swiss law strictly frames this borrowing. The Collective Investment Schemes Ordinance sets a clear limit: where mortgages are created on the buildings, all of a fund's properties may be charged, on average, only up to one third of their market value (art. 96 para. 1 CISO, on the basis of art. 65 CISA). In other words, for one hundred francs of buildings, mortgage debt must not, as a rule, exceed thirty-three francs.

This limit is not indicative: it is a regulatory ceiling, checked by the fund's audit firm. It pursues a protective goal: to prevent a fund aimed at non-professional investors from taking excessive leverage risk, which would turn a moderate fall in property prices into a collapse of equity.

The same text provides a relief valve, just as tightly framed. In order to preserve liquidity, the debt ratio may be raised temporarily and exceptionally to one half of market value, on two conditions: that the fund rules allow it, and that investors' interests remain protected (art. 96 para. 1bis CISO). The audit firm takes a position on whether those conditions are met (para. 1ter). One third is thus the rule, one half the supervised exception – never a permanently open right.

The Amplification of Net Asset Value

It is on net asset value that leverage reads most clearly. The NAV is the value of the buildings minus the debts; and the debt does not move when the buildings are revalued. All the variation therefore falls on the equity, which is only a fraction of the total – hence the amplification.

A fictional example shows it. Take a fund holding 100 of buildings, financed by 30 of debt and 70 of equity – a debt ratio of 30%, within the bounds of the one-third rule.


Value of the buildings	Debt	NAV (equity)	Change in NAV
Starting point: 100	30	70	—
Buildings +10% → 110	30	80	+14.3%
Buildings −10% → 90	30	60	−14.3%

A 10% change in the value of the buildings produces a change of about 14% in the NAV. Leverage multiplied the move by nearly one and a half – on the way up as on the way down. The higher the debt, the larger this amplification coefficient grows; that is exactly the rationale for the legal cap. This mechanism echoes volatility drag: a more volatile NAV compounds less well over time, at an equal average return.

The Denominator Trap

Leverage's subtlest danger comes not from the borrowing itself, but from its ratio. The debt ratio measures debt against the value of the buildings. When that value falls, the numerator stays fixed but the denominator shrinks – and the ratio climbs without any new borrowing being taken on.

Take the example again. At the start, 30 of debt on 100 of buildings makes a ratio of 30%. If the buildings fall to 90, the same 30 of debt now represents 33% – the one-third cap reached. A further fall would breach the legal limit, forcing the fund to react: sell buildings at the worst moment, or raise equity to restore the ratio.

This is one of the drivers of capital increases in times of stress. A fund does not always raise capital to grow; it sometimes does so to deleverage its balance sheet and drop back below the cap, mechanically breached by the fall in valuations alone. Our article on capital increases details this logic; leverage is often its hidden cause.

Leverage, Interest Rates, and the Premium

Leverage finally links the real estate fund to the world of interest rates in two ways. First, it sets the cost of the debt: when mortgage rates rise, the cost of borrowing approaches the rental yield, the favorable gap compresses, and the benefit of leverage erodes. Second, it amplifies the volatility of the NAV, which tends to accentuate the moves in the premium or discount – the gap between the market price and the NAV that our article on agio and disagio examines.

A heavily leveraged fund is thus doubly sensitive to rates: through the cost of its debt and through the market's mood toward income assets. The one-third rule does not remove this sensitivity, it bounds its size – which, in turning phases, makes all the difference between a correction and a crisis.

In Practice

Three reflexes make it possible to read a fund's leverage without forecasting the markets.

Place the debt ratio against the cap. A fund at 20% debt has a comfortable margin; a fund near one third has little cushion before it must react to a decline. The annual report publishes this ratio – our reading guide shows where to find it.
Think of the ratio dynamically, not statically. A low debt ratio in good times can tighten quickly if valuations recede, through the denominator alone. The useful question is not "where is the ratio today?" but "where would it be after a 10% or 15% fall in the buildings?"
Weigh leverage against the rate gap. Leverage adds return only as long as the rents earn more than the debt costs. Checking that gap, and how well it holds up against a rate rise, tells you whether leverage is working for or against unitholders.

Conclusion

Leverage is the quiet engine of Swiss real estate funds' performance, and the source of their main fragility. It amplifies everything – returns in favorable times, losses and balance-sheet strain in adverse ones – and that amplification reads directly in the movements of net asset value. The one-third rule, completed by its framed one-half exception, does not abolish this risk: it caps it, and forces the fund to react before it becomes systemic.

Understanding leverage means ceasing to read the debt ratio as a fixed figure and reading it as a living tension, one that rises when prices fall and that ties the fund to the cost of money. It also means understanding why the same fund can look prudent at the top of the cycle and constrained at its trough, without having changed anything about its debt – only having endured the fall that tightened its ratio.