When the Debt Costs More Than the Asset Earns

TL;DR

Cap rate measures what a property earns relative to its purchase price — independent of how it's financed. Interest rate measures what the debt costs. When the interest rate exceeds the cap rate, every leveraged dollar is working against you. The asset is generating less than the financing costs, and that gap comes directly out of LP returns until NOI grows enough to close it.

This isn't automatically a deal-killer. Value-add strategies routinely acquire at below-market cap rates with a thesis that renovation, lease-up, or rent growth will push NOI to stabilized within the hold period. The gap is the bet. The question is whether the GP has named it, modeled it, and disclosed what happens when the timeline slips.

In most decks we review, the answer is some version of no.

When a deal carries floating-rate debt — bridge loans, construction financing, variable-rate credit facilities — the debt cost isn't fixed. It moves with the index. In a negative leverage structure, that means the gap between what the asset earns and what the debt costs can widen without warning.

The standard protection against this is a rate cap: a contract that limits how high the floating rate can go. It costs money, it has an expiration date, and sophisticated LPs ask about it on the first call.

Among floating-rate deals in our database, 62% carry no disclosed rate cap. That isn't a structuring oversight. It's a disclosure choice. An LP reviewing those decks has no way to assess the ceiling on their interest expense — because the ceiling either doesn't exist or wasn't mentioned.

In a stable rate environment, this risk is easy to dismiss. The last three years demonstrated what happens when it isn't.

Interest-only periods are one of the most LP-relevant features of any debt structure. During an IO period, the borrower pays only interest — no principal reduction. For LPs, this matters in two directions: IO periods preserve cash flow during lease-up, which is GP-favorable; but they also defer principal paydown, which concentrates refinancing and exit risk at the back end of the hold.

Understanding whether a deal has an IO period, how long it lasts, and whether it covers the full projected hold period is basic due diligence. It requires one disclosure.

In our database, more than half of all debt records contain no IO disclosure at all. Not "no IO period" — no disclosure. The field is simply absent from the offering materials. LPs reviewing those decks cannot evaluate a fundamental component of the deal's cash flow structure without asking for it directly — and knowing to ask requires understanding why it matters in the first place.

That's the gap LP Intel exists to close.

Projected IRR is the number GPs lead with. Debt structure is what determines whether that number is achievable. Negative leverage at acquisition, floating rate exposure without a cap, and undisclosed IO terms are not footnotes — they are the structural conditions under which LP capital either compounds or erodes.

None of these are obscure. All of them are calculable or askable from information that should be in every deck. The problem isn't that the math is hard. The problem is that most LPs don't know which questions to ask until after the hold period ends badly.

Ask this before your next capital commitment:

"What is the going-in cap rate on this acquisition, what is the all-in cost of your debt at closing, do you have a rate cap in place and when does it expire, and does the interest-only period — if any — cover your full projected hold?"

Four questions. One paragraph. A GP who has structured the deal thoughtfully will answer all four without checking their notes. A GP who hasn't will find the conversation surprisingly difficult.

LP Intel reviews private real estate syndication deal decks and scores them against a standardized due diligence rubric. Nothing in this newsletter constitutes investment advice or a recommendation to buy or sell any security. All data is sourced from LP Intel's proprietary database of reviewed deal materials. Past performance of reviewed operators is not indicative of future results. For informational and educational purposes only.