You’re evaluating a deal – maybe a condo redevelopment in Manhattan or a multifamily project in Miami. The developer approaches you to come in as a partner. You’re putting up most of the capital, and in return, you’re promised a share of the project’s profits.
Sounds good, right? You’re the money, they’re the execution, and together you’ll split the upside.
But here’s the catch: if you’re providing the bulk of the money, you should be lending at a real, economic interest rate – not a subsidized or “friendly” one.
Economic vs. Preferential Interest
This is where many investors slip up. They agree to fund deals at below-market rates because they’re told, “Don’t worry, you’ll make it up in profit participation.”
That’s a mistake.
- Economic interest = financing at true market rates that reflect the actual cost of capital in today’s environment.
- Preferential interest = below-market rates, which effectively serve as a hidden premium you’re paying to the developer.
By offering preferential terms, you’re not doing yourself a favor – you’re doing the developer a favor. You’re giving away value before the deal even starts.
Why Demand Economic Interest?
There are several reasons why insisting on market-rate financing is non-negotiable if you’re the capital provider:
1. Protects You from Disguised Subsidies
Cheap financing is essentially giving the developer extra value, but in disguise. They get to use your money at a bargain rate, while you take on the same risk.
If you’re supplying most of the capital, you deserve compensation that matches today’s cost of money.
2. Sets a Minimum Floor Return
Especially in a high-rate environment, your floor matters. A true economic interest rate guarantees you a minimum level of return regardless of how the profit distributions shake out.
That floor could be the difference between walking away whole – or bleeding capital in a project that underperforms.
3. Fair Compensation for Risk
Single-project investments – particularly unsecured mezzanine-style loans – carry real risk. Construction delays, entitlement issues, market shifts – any one of these can derail returns.
Your interest rate should reflect that reality. Double-digit returns aren’t greedy in this context – they’re market standard.
4. Cleaner from a Tax Perspective
In some cases, interest income can be treated more cleanly for tax purposes than profit distributions. The details depend on jurisdiction, but structuring your return as interest often simplifies accounting and compliance.
5. Lets You Act Like a Bank
Perhaps most importantly, charging economic interest lets you behave like a bank. Banks don’t fund projects at “friendly” rates – they lend at market, capture the spread, and let the borrower take the equity risk.
By locking in true interest, you create arbitrage.
Example: The $1M Investment
Let’s put numbers to it.
You invest $1,000,000 into a project.
- At a 12% economic rate, you’re locking in $120,000 per year in interest payments – before even touching profit distributions. That’s a predictable, contractually obligated return.
- At a 6% “friendly” rate, you’re getting just $60,000 a year. The other $60,000? That’s a hidden gift to the developer, who effectively borrowed at below-market cost.
Multiply that difference over three years, and you’ve handed over $180,000 of value – without even knowing it.
How Much Should You Ask For?
There’s no single “right” number – it depends on the project’s risk profile and what security you receive. But here are some broad guidelines:
- Senior secured, low-risk financing: mid-to-high single digits may be appropriate.
- Single-project, unsecured mezzanine-style financing: double digits are standard.
- Higher-risk development deals (no permits, early-stage land): rates may climb well above 12-14%.
A good rule of thumb:
👉 Interest rate = your cost of capital + a spread (2-3%).
That ensures you’re always capturing arbitrage, not just lending at breakeven.
The Developer’s Pushback
If you insist on market-rate financing, expect some pushback. Developers may argue:
- “You’ll get it back in profit.”
- “This is how everyone else funds deals.”
- “We need cheap money to make the numbers work.”
But that’s exactly the point. If the deal only works with subsidized financing, it’s not a deal – it’s a transfer of value from you to them.
A strong developer should be able to make the economics work while still paying you fairly for your capital. If they can’t, it’s a red flag.g.
The Bottom Line
If you’re providing the bulk of the money in a real estate project, don’t settle for “friendly” rates.
Demand economic interest that reflects today’s market cost of capital. Doing so:
- Prevents hidden subsidies.
- Locks in a floor return.
- Compensates you fairly for risk.
- Simplifies tax treatment.
- Allows you to act like a bank and capture arbitrage.
In today’s expensive money cycle, insisting on real economic interest isn’t optional – it’s essential.
👉 For more straight talk on real estate and finance – based on real deals, not theory – hit subscribe to Getting Real with Peleg.
Leave a Reply