What happens if the interest rate rises before closing?
The seller’s debt case uses 6%. The lender now quotes 8%, while the lease still rolls in year 2.
The question
Willow Industrial is an invented 100,000-square-foot U.S. warehouse. All amounts are in U.S. dollars. The hold lasts five years. No rent growth, tax, depreciation, promote or refinancing is modeled.
| Assumption | |
|---|---|
| Purchase price | $16m |
| Interest-only debt | 60% of purchase price |
| Year 2 NOI | $800,000 |
| Year 2 lease costs | $540,000 |
| Old interest rate | 6% |
| New interest rate | 8% |
Acquisition costs are 2% of price, funded by equity. The loan has no principal payments during the hold.
“Compare interest coverage and the year 2 equity call at both rates. Explain whether higher debt still helps.”
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A strong answer, step by step
Open each step in turn. This is one strong answer, not the only one.
Step 1: Keep the loan amount fixed
What would you do here? Open the move you’d make.
Apply 8% to total purchase price.
Tempting, but it misses something. Equity does not bear loan interest.
Apply 8% to $9.6m.
The strong move. That is the outstanding principal.
See how a strong candidate says it
“The loan is $9.6m. The new rate does not change principal by itself.”
Why it works: A loan quote can change cost without changing leverage.
Step 2: Use the weak year’s NOI
What would you do here? Open the move you’d make.
Use $1.08m to report 1.41x.
Tempting, but it misses something. That hides the period with lease downtime.
Use $800,000 of year 2 NOI.
The strong move. Stabilized income has not arrived for a full year.
See how a strong candidate says it
“Interest rises from $576,000 to $768,000. Year 2 DSCR falls from 1.39x to 1.04x.”
Why it works: For interest-only debt, the denominator is annual interest. Use the cash-flow year that actually occurs.
Step 3: Show the equity effect
What would you do here? Open the move you’d make.
Say the loan is covered and stop.
Tempting, but it misses something. Coverage alone omits the capital costs borne by equity.
Add $192,000 to the call.
The strong move. Capital costs are unchanged.
See how a strong candidate says it
“The year 2 equity call rises from $316,000 to $508,000.”
Why it works: The extra $192,000 of annual interest is cash that equity must fund.
Step 4: State a workable change
What would you do here? Open the move you’d make.
Assume the interest rate falls next year.
Tempting, but it misses something. No rate path is in the packet.
Trade lower debt for more equity at closing.
The strong move. The constraint has a capital cost.
See how a strong candidate says it
“If the team requires 1.25x coverage in year 2 at 8%, debt cannot exceed $8m. That adds $1.6m to equity at closing.”
Why it works: This is an internal case constraint, not a claim about a lender’s actual covenant.
The answer, in short
- Decision
- Re-underwrite the price and equity need at 8%.
- Because
- At the same loan balance, the lease-roll year has little interest coverage and needs a $508,000 contribution.
- What would change it
- An $8m loan meets the case’s 1.25x coverage target, but raises closing equity by $1.6m.
The lender fixes the rate at 8% and offers no extra capital for tenant work. What changes in your bid?
Common traps
- Calling debt coverage a full cash-flow test.
- Assuming refinancing or rate cuts without terms.
Check your answer
- I held principal fixed before changing the rate.
- I used the weak-year NOI.
- I showed the extra equity contribution.
- I named the cost of reducing debt.
Last reviewed Nov 10, 2026