Generally, real estate investments can be of two kinds- equity investments and debt investments. Equity investors are part owners of a real estate property, where debt investors are lenders to the company.
Before going further, let’s see what equity investments and debt investments are.
Equity Investments: Real estate equity investors are the shareholders for a particular property. They receive their return on investment through capital gains when their investment property is being sold, or rental income that the tenants pay. The rate of return for these investors depends on the profit that the property makes. As shareholders, equity investors share the risks in proportion to their investment as well.
Debt Investments: Debt investors, on the other hand, investing in debt instruments, loan out their money to a company for a particular period with an assurance of an interest rate, along with the return of principal. Unlike equity investors, these real estate deals associate with minimum risk, as the investors are at the bottom of the capital stack, receiving the return whether or not the company makes a profit.
The Difference Between Equity and Debt in Real Estate Investments
Being widely different investment options, equity investment, and debt investment offer unique returns and risks for investors.
Returns On Investment
An equity investor shares the income from a real estate project in proportion to the investment. The capital gain is being calculated once the debt and other interests have been paid off. An equity investor enjoys unlimited potential returns, depending on how successful a real estate project gets! Preferred equity holders, in extension, get preference during payouts to common equity investors.
A debt investor, on the other hand, receives only interest income from the investment, irrespective of the cash flow from the real estate project. The principal capital is being returned to a debt investor once the project is over. Returns for this real estate investment is capped (or limited) depending on the original loan (debt), and the interest rate is agreed upon between two parties.
Risk Profile For Equity And Debt
All investors in a commercial real estate deal, equity and debt investors alike, share some risks. Higher risk always comes with higher potential returns. Less risk, on the contrary, is accompanied by limited returns.
Typically, equity investors face higher risks, as their investments are not secured. If a real estate can’t make a profit out of an investment, equity investors have to carry that loss.
A debt investment, on the contrary, comes with a profile of lower risk. In case of losses, a company has to secure its real estate debts first through their assets. In the case of project failure, a property may get foreclosed and the debt investors receive the full or a portion of their investment through selling the assets.
Debt investors get fully paid before equity investors receive any return on their investment when a project fails. Bottom line, debt investment is a safer investment option with less potential returns.
In general, real estate investing using debt is a short term option in comparison to equity investment. Debt funds, for example, are raised to purchase a property and to bear construction expenses. These debts are often repaid through pre-sales or early sales, often when the project work is underway.
Equity real estate investing, on the other hand, results in returns only when the property is fully sold or rented out. These investors start sharing profits once all debt investments are repaid or covered by the monthly cash flow.
The Bottom Line
Equity or debt investment is an investor’s choice. Investors with higher return investment goals and better risk tolerance generally go for equity investment. Consider the higher risk which is associated with this investment and perform due diligence as needed prior to moving forward. Investors who prefer steady income with lower risks ideally go for debt investment.
If you have any questions about real estate investing with a syndicate, please reach out to us. Investing with a private equity firm is a fantastic choice as opposed to real estate crowdfunding or investing with a REIT. At First National Realty Partners, we can help you design the commercial investing portfolio that balances potential profits while minimizing investment risks. Our goal is to make it possible for investors like you to get started in these real estate investing opportunities. Contact us any time to learn more about the services that are offered.
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