The interest rate on mortgage debt on investment property does curtail capital appreciation, but it certainly doesn’t add risk and it certainly doesn’t make investment real estate a bad deal compared to other investments.

Here is how it works. Most folks, including myself, advise re investors to make their properties cash flow for safety (comparing your costs with the rents received). So if one person can get a loan for 7% and the other can only get a loan for 9% in order to make it cash flow, the later will have to put down more capital (down payment). If you are leveraged at 80% LTV and a property cash flows you only have to tie up that 20% capital. However, if you are having to put down 25% to make the property cash flow because of a high interest rate on the loan then you have 5% more capital tied up in the property for the same capital appreciation.

$100,000 property
Person A cash flows with $20,000 down payment
Person B cash flows with a $25,000 down payment

Property appreciates 3% for five years. Aproximiate value of $116K.
For simplicity stake; No excess cash flow for five years (unlikely)
No tax advantages.

Person A ROI= 12.47%
Person B ROI= 10.4%

Having to put that extra $5K down to make the property cash flow cost you 2% in the return department. Note that the property only appreciated 3% per year, yet the rates of return were 10% and 12%!

Now in the real world you must account for the cash flow over time and the tax advantages to compute ROI. But this is a perfect example of how interest rates effect return. Also, note that the higher the leverage (above 75% LTV for most folks) the higher the interest rate is likely to go. So, there is usually a break even point for leverage/cash flow that takes into consideration the interest rate.