Debt vs. Equity in Real Estate Investing
Thursday Jul 21st, 2022
Real estate investment is a great way to increase your equity. As the Equity Master, my area of expertise lies in the ability to manage equity in a way that makes it work for you, not against you. In this post, I’d like to discuss a frequently asked question I get from clients, ‘what’s the difference between debt and equity in real estate investing?’
Equity investments are when you buy an asset that gives you a profit based the asset’s performance. More than that, because you are investing in the property itself, you are entitled to a portion of the capital gained by the asset. This can include buying and managing a rental property. When it comes to equity. Investing, the game then is how to manage your stock of assets.
Pros of Equity Investing
- No limit to the amount of money you can invest
- Can expect a range of 18% - 25% annualized returns
- No cap on investors
- Potential for lower fees for equity investments
- Tax advantages for investing in equity
Cons of Equity Investing
- Longer-term investment (portfolio not as liquid)
- Increased risk if not managed properly
When an investor invests in real estate debt, they act as a lender to the property owner or deal sponsor. Investors get a fixed rate of return based on the loan’s interest rate and amount invested on the loan the property has taken out. Investors here have first rights to the property payout. Investing in mortgage-backed securities is another way to invest in real estate debt.
When you invest in real estate debt, your money is backed by the property as collateral. This can be done in a real estate debt fund and is a unique form of debt investment that can provide a steady return.
Pros of Debt Investment
- Mostly investing in building projects – shorter holding period than equity investments (6 – 24 months).
- Better balance of risk levels – more chance to ensure recouping your investment
- Fixed ROI based on interest rate on the loan and your investment amount
- More predictable ROI – 8% to 12% annually
Cons of Debt Investment
- You can only earn a predetermined amount of money – capped returns
- Fees incurred if investing with a crowdfund
- Projects may be completed earlier, disrupting cash flow
The Differences between Equity and Debt Investments
There are a few things to keep in mind with each type of investment, with key differences between one and the other:
The risk level in both types of investments varies. Equity is more dependent, but debt is entirely fixed by interest rates. You may lose your investment if the equity doesn’t perform well, but if property owners fail to make payments, you can still get your investment from the property itself.
Depending on the type of investment you chose, you may just be a stakeholder and not an owner.
There is a limited amount of returns on debt investments because they are capped. Equity investments on the other hand depends on the amount of shares you invested in, and the performance of the property.
Debt investments need substantial fees in the beginning, while equity investment fees are lower and charged at an annual rate instead of monthly.
Both types of investments have their pros and cons. What the best decision is for you depends on your portfolio, and your capabilities. Both can provide good returns on investment with steady cash flow. And if you are a long-term thinker, putting the money aside to continue to work for you is for your benefit. If you’d like to figure out the best way to invest, and what type of investment is more suitable for you, contact me today for a free consultation. Every step counts.