Leverage is usually described as though it always amplifies a return. It amplifies the spread between what the asset earns and what the debt costs — and that spread can be negative. When it is, every additional dollar borrowed makes the cash-on-cash return worse, not better.
The threshold is not the interest rate. It is the mortgage constant: annual debt service divided by the original loan amount. On an amortising loan the constant is always above the interest rate, because it includes principal.
Computing the constant
For a fully amortising loan, the constant is the monthly payment factor times twelve. At 6.75% over 30 years the monthly factor is 0.006486, so the annual constant is 7.78% of the loan.
At 75% loan-to-value that is 5.84% of the purchase price going out as debt service every year. So a property has to produce net operating income above 5.84% of price — a 5.84% cap rate — before a dollar of cash flow survives the mortgage.
| Rate | Mortgage constant | Break-even cap at 75% LTV | Break-even cap at 70% LTV |
|---|---|---|---|
| 5.75% | 7.00% | 5.25% | 4.90% |
| 6.25% | 7.39% | 5.54% | 5.17% |
| 6.75% | 7.78% | 5.84% | 5.45% |
| 7.25% | 8.19% | 6.14% | 5.73% |
| 7.75% | 8.60% | 6.45% | 6.02% |
What that does to a Phoenix panel
Most Phoenix single-family in the current market underwrites to a going-in cap rate between 3.2% and 4.8% once taxes, insurance, management and a real capital reserve are carried honestly. Every one of those rows sits below the break-even cap at any rate above about 4%.
That is not a defect in the analysis. It is the market: a 4% cap asset financed at a 7.78% constant produces negative cash flow, and the buyer is paying for appreciation, amortisation and tax treatment rather than for income.
Small multifamily is where the arithmetic changes. Four 2/1 doors at roughly 880 square feet each generate materially more rent per dollar of price than one 1,600-square-foot house, and that is why the top of a Phoenix yield screen is dominated by duplex, triplex and fourplex product.
Three honest responses
- Buy the yield. Move down in unit size and up in door count until the going-in cap clears the constant. This is what most of the positive-cash-flow rows in our panel have in common.
- Change the capital structure. More equity lowers the debt service but does not change the cap rate, so it converts a negative cash flow into a lower cash-on-cash — sometimes the right trade, never a free one.
- Underwrite the appreciation explicitly. If the case is total return rather than income, say so on the face of the model and state the growth assumption, so someone can disagree with it.