Definition
Interest carry refers to the ongoing interest expense incurred on borrowed funds during development, renovation, or lease-up, before a property generates sufficient income to cover its debt service. It is a major component of project financing costs.
When Interest Carry Occurs
- Ground-up construction projects
- Major value-add renovations
- Extended lease-up periods
- Bridge loan situations awaiting refinance
How It Works
During construction, loan proceeds are typically drawn in phases. Interest accrues on the outstanding balance and is either:
- Paid monthly from equity or operating reserves
- Capitalized into the loan balance (increasing total project cost)
Example
A developer borrows $15 million at a 7% interest rate with a 24-month construction timeline.
- Annual interest: $15,000,000 × 7% = $1,050,000
- Two-year interest carry ≈ $2,100,000 (excluding phased draw adjustments)
If the project is delayed by six months, interest carry increases materially, reducing overall returns.
Why It Matters
- Return sensitivity: Directly reduces project margin.
- Timeline risk: Delays increase financing expense.
- Rate volatility: Floating-rate debt increases exposure.
- Feasibility impact: Higher rates may eliminate profit cushion.
Risk Factors
- Construction delays
- Permit or entitlement slowdowns
- Slower-than-expected lease-up
- Rising interest rate environment
Investor Implications
- Capital reserves: Adequate liquidity is critical.
- Hedging strategy: Rate caps or swaps may reduce volatility.
- Execution discipline: Tight project management limits exposure.
- Underwriting conservatism: Sensitivity analysis protects against overruns.
Common Pitfalls
- Ignoring rate increases on floating loans
- Underestimating lease-up timelines
- Failing to include interest carry in total development cost
- Weak contingency planning