Why the loan constant is not your interest rate
Loan Constant = Annual Debt Service ÷ Original Loan Amount
The interest rate tells you the cost of borrowing. The loan constant tells you the cost of borrowing plus the pace at which the lender requires you to hand the money back. On an amortizing loan those are two different numbers, and the second one is what actually leaves your bank account.
Take a $5,000,000 loan at 6.5% with a 25-year amortization. The payment is about $33,760 a month, or $405,100 a year. Divide that by the original balance and the loan constant is 8.10% — roughly 160 basis points above the note rate. Stretch amortization to 30 years at the same 6.5% and the constant falls to about 7.58%. Make the loan interest-only and the constant equals the rate exactly, 6.50%.
Same rate, three materially different cash costs. That is the entire reason the metric exists.
Positive and negative leverage
Set the loan constant next to the property's cap rate and you get an immediate read on whether borrowing helps or hurts:
- Cap rate above the constant → positive leverage. Each borrowed dollar earns more inside the property than it costs in debt service, so your cash-on-cash return finishes above the cap rate.
- Cap rate equal to the constant → neutral leverage. Borrowing changes the size of the bet, not the return.
- Cap rate below the constant → negative leverage. Every additional dollar of debt pulls your cash-on-cash return down. More borrowing makes the deal worse, not bigger.
This is a one-line sanity check you can run on any deal in about ten seconds, before you build a model.
Worked example
A $7,000,000 property financed with a $4,550,000 loan at 65% LTV, priced at 6.5% on a 25-year amortization. The 8.10% constant puts annual debt service at about $368,700, and your equity in the deal is $2,450,000.
- Scenario A — NOI of $595,000, an 8.5% cap rate. Cash flow after debt service is $595,000 − $368,700 = $226,300, a cash-on-cash return of 9.24%. The cap rate cleared the constant, so leverage pushed the return above the unleveraged 8.5%.
- Scenario B — NOI of $490,000, a 7.0% cap rate. Cash flow is $490,000 − $368,700 = $121,300, a cash-on-cash return of 4.95%. The constant beat the cap rate, so leverage dragged the return below the unleveraged 7.0%.
Identical property price, identical loan, identical equity. The only variable is whether the building out-earns its own debt.
Scenario B is not automatically a bad investment. Plenty of buyers accept negative leverage on day one for an asset they expect to grow into through rent increases or lease-up. The failure is doing it without knowing you are doing it.
What it means for you
The constant is also the cleanest way to compare loan offers that are otherwise hard to line up. A 6.75% rate on a 30-year amortization carries a constant of about 7.78%. A 6.25% rate on a 20-year amortization — the better-looking rate — carries a constant of about 8.77%. The second offer takes roughly a full percentage point more of your loan balance in cash every year, even though its headline number is half a point lower. You are building principal faster, which is real value, but it is not cash flow and it will not pay for a roof.
Run the constant on every offer before you compare rates, using our CRE calculators if you would rather not do the amortization math by hand, and read the result against the terms on the current CRE rates page. When you want the comparison run on live quotes rather than assumptions, send us the property and we will lay the offers side by side.
What to watch for
- Interest-only flatters the constant temporarily. During an IO period the constant equals the rate, so a deal can show positive leverage for three years and flip to negative the month amortization begins. Model the post-IO constant, not the teaser.
- Amortization is often more negotiable than rate. Moving from 25 to 30 years on the example loan cuts about 52 basis points off the constant — more cash relief than most borrowers ever extract from a rate negotiation.
- Test it against trailing actuals. Comparing the constant to a broker's pro forma cap rate will show positive leverage that does not exist yet. Use the cap rate implied by the trailing twelve months.
- The denominator is the original balance. As principal amortizes the payment stays fixed while the balance shrinks, so the constant measured against the remaining balance climbs over the life of the loan.
- A low constant can hide balloon risk. Long amortization lowers your annual cost and leaves a larger balance outstanding at maturity, which is a refinance exposure in whatever rate environment happens to exist that year.
How do you calculate the loan constant?
Add up twelve months of principal and interest payments and divide by the original loan amount. A $5,000,000 loan with a $33,760 monthly payment produces $405,100 of annual debt service, and $405,100 ÷ $5,000,000 = 8.10%. You only need three inputs to derive it from scratch: the rate, the amortization period and the loan amount.
What is positive leverage in real estate?
Positive leverage means the property's cap rate is higher than the loan constant, so borrowing raises your cash-on-cash return above what an all-cash purchase would produce. Negative leverage is the reverse: the debt costs more annually than the asset earns, so each additional dollar borrowed reduces your return. Both are calculations, not opinions, and they take one line to check.
Is the loan constant the same as the interest rate?
Only on an interest-only loan. On any amortizing loan the constant is higher, because it includes principal repayment. The gap widens as amortization shortens — at 6.5%, a 30-year schedule gives a 7.58% constant, a 25-year schedule gives 8.10%, and a 20-year schedule pushes it higher still.
