Real Estate Equity vs Debt Investment
When you think about it, a good number of real estate investment opportunities abound in the market. But then you are stuck in a comparison of real estate equity vs debt investment?
What is the difference between debt and equity investments? Which one among these real estate investment options is suited for your current financial situation, goals, and risk appetite?
These are some of the questions we’ll be answering in this post. By helping you think through these comparative differences, you’ll get in a better position to decide what is best for you or your company.
What Are The Differences Between Real Estate Equity And Debt Investment?
Most real estate investments are capital intensive. However, following some of these options lowers the entry barrier for many individual and corporate investors. Regarding the entry requirements, below are the core differences between the two options discussed in this post.
Buying into real estate equity investment is like investing in the stock. The units of equity investments can be relatively low. That makes it easier for some people to invest without waiting for capital accumulation. For this type, you can invest through a real estate crowdfunding platform.
On the other hand, debt investments are structured in a way that requires lump sum capital. Most people structure their real estate debt investment deals like this to meet their project funding goals. And that’s what makes it relatively unaffordable for many potential investors.
Type of Return
Although these two types of real estate investments will earn you profit, the terms are rarely the same. Thinking about real estate investment returns, here are the differences between real estate debt and equity investment.
With an equity investment, your potential profit will not be limited.
That means you are entitled to any level of profit made during the lifetime of your investment. If the real estate venture records exceptionally high profits, you’ll be entitled to a defined share of the profit without any limitations. Contrary to this, debt investors will only be entitled to a defined and agreed rate of return documented before the investment.
In this case, it doesn’t matter the level of profit earned through the real estate venture. Your return is always limited to the agreed rate of return. However, real estate debt investment is known to produce relatively stable and predictable returns.
The level of risk involved with these two types of real estate investment is never the same. Here is another reason you should take time to take time and compare the differences between real estate equity and debt investment. Perhaps, risk tolerance level often differs among different segments of investors.
When there is any failure or bankruptcy, real estate debt investors are entitled to receive their money before equity investors. That is because debt investors can foreclose properties to recover their money. Hence, the borrowers must pay what they borrowed.
For most real estate equity investment deals, operator fees are performance-dependent. When they perform well by producing higher profits, they earn higher operation fees.
The same thing happens when they perform poorly. On the other hand, the operation fees involved in real estate debt investment are a fixed type. Comparatively, what they earn from their services is higher than that of equity investment managers.
Assuming you want to get more insights, you may want to contact some real estate investment professionals operating on both sides of the table. From these people, you can get more factual information that will help you compare the operating fees.
Just like traditional stocks, real estate equity investment has the potential for progressive or profitable value appreciation. For example, let’s say a commercial property was bought for $400,000. And the value goes up to $940,000 within three years, you will be entitled to the financial benefit of that value appreciation. When the property is sold, you’ll benefit from that value appreciation as an investor.
Debt investments, on the other hand, do no appreciate. Once again, you are only entitled to a defined rate of return relative to the amount you invested.
Real estate debt investments have relatively shorter time commitments. Depending on the structure of the deal, the duration can range between 6 months to 2 years. That means you can get in and out within a short period. Comparatively, equity investments require longer hold periods. Think about 3 – 10 years duration. This longer hold period is required for the investment property to have any chance of value appreciation.
Depending on your risk tolerance level, going for the highest real estate investment profit is a good thing. However, while you are swinging for the fences, it is important to think about the safety of your investment. Here is another interesting difference between real estate debt and equity investment.
Most debt investments in real estate are usually backed by collateral. And that is the property you are investing your money in. That’s why the level of risk is relatively lower. The chances of recovering your money in the event of any unusual market infractions or operations failure are always higher when compared to real estate equity investment.
As you can see in this post, there are many differences between debt and real estate investment. Hence, it’s not just about the entry requirements. Being affordable to accommodate a higher number of small investors is a good thing. Try to compare these investment options based on the core differences discussed above.
While you are at it, try to take your risk tolerance level and investment goals while making your comparison. From there, you’ll be able to decide what is best suited for you.
Assuming you are just starting, you may want to consider smaller debt investments with relatively lower risk.
Taking that route will allow you to learn about the operating processes before going in full-time. However, real estate equity investment might be your best option if you have the risk-taking capacity.
Please note that nothing written in this is concrete financial advice. Before making any investment, endeavor to consult a financial advisor.