Real estate investing is a highly varied investment strategy that involves the purchase or sale of real estate in order to gain profit. Once real estate is invested in, it’s also possible to own, manage, or rent the property depending on the exact strategy you would like to use. There are many different ways that an investor can place money into real estate, which includes everything from real estate trading to real estate investment trusts.
One notable type of real estate investing is debt investing with real estate, which involves providing borrowers with loans that they can use to purchase or develop real estate. You could also choose to invest in mortgage-backed securities as a form of real estate debt investing. When you invest in real estate debt, your investment is backed by the real estate asset serving as collateral. One notable form of debt investing involves placing money into a real estate debt fund, which is a popular type of investment pool that can net you a stable return.
You could also choose to make equity investments, which involve purchasing an asset that will provide you with a profit that’s dependent on the performance of the asset. One notable aspect of investing in equity is that you will be entitled to a specific share of the capital that’s gained by the asset. While there are a wide variety of different kinds of equity investments, one notable example is purchasing and managing a rental property where you gather income from the monthly payments that each renter must make.
One main difference between these investment types is that equity investors continue making money off of the asset as long as it performs well, which isn’t the case with a debt investment. If you’re currently interested in investing in real estate but are unsure if equity investments or debt investments would be better for your portfolio, the following article will go into detail about the pros and cons of each.
Pros and Cons of Debt Investments
Debt investments are an option for investors who want to better balance the overall risk of their investment portfolios. When you invest in debt investments for real estate, you will be acting as the lender to the property owner or the sponsor of the deal. While there’s always a chance that the borrower will not deliver the results that you expect from them, the loan is directly secured by the actual property, which means that you will be able to take control of the property if the borrower defaults on the loan.
When investing in debt, you will receive a fixed rate of return that’s determined by the interest rate on the loan and by how much money you have invested. Even though the fixed rate of return that you receive depends mostly on the interest rate that is set for the loan, it can be beneficial to know that you’ll obtain the same payments each month.
There are a wide variety of positives that come with investing in debt, the most notable of which is that these investments are considered by many to be safer than equity investing. The loan that you make will be secured by the property that the borrower wishes to purchase, which allows the property to be used as a kind of insurance policy for repayment of the loan. If the sponsor or property owner happens to default on the property, you can recoup the losses of your investment by foreclosing on it.
These loans generally have a much shorter hold period. Debt investments are usually associated with actual development projects, which means that the loan should be paid back in full at the completion of the project or soon thereafter. The holding period attributed to most debt investments is anywhere from six months to a couple of years. If you want to maintain a high amount of liquidity in your portfolio, this is a good form of investment. Another benefit of investing in debt is that it provides you with a steady income that’s predictable. Whether you are paid monthly or quarterly, you will know the frequency of the payouts you receive as well as the amount that you will receive since it’s based on the interest rate that has been set for the loan.
While there are numerous positives to investing in debt, there are also a few problems that you should keep in mind. Unlike equity investments, the debt investments that you make have a capped return. The returns you obtain are limited by the set interest rate, which means that equity investments have the potential of providing higher returns. There are also significant fees that come with participating in debt investment crowdfunding. The platform will take a small percentage of the money that’s earned through crowdfunding.
Pros and Cons of Equity Investments
An equity investment is a form of investing where the investor acts as a shareholder in the property that they’re investing in. The stake that they have in the property directly correlates with the amount that they’ve invested. The most notable aspect of investing in equity is that returns are obtained in the form of a certain share of the income that the property is able to generate from the rental payments. The amount that you receive is reduced slightly depending on the exact platform that you use to make the equity investment. Investors can also receive payments from the share that they have in the event that the property is eventually sold. These payments come directly from any amount of appreciation on the property.
There are many positives that come from investing in real estate equity. For one, these investments have the ability to generate high returns. These returns could be as high as 20 percent or greater. If the property is successful, its value could increase, which would lead to you receiving even more profit than you had anticipated. It’s also important to note that there is no cap on returns, which theoretically gives you the ability to make a large profit in comparison to your initial investment. If the asset happens to perform exceptionally well, you will be able to reap the benefits.
While equity investing is great if you want to maximize your returns, the main issue with investing in equity is that it often requires a lengthy hold period, which refers to the time between your purchase of the asset and your eventual sale of the asset. Holding onto an equity investment for a lengthy period of time may not be advisable if you’re interested in maintaining a high amount of liquidity in your portfolio.
Another negative aspect of investing in equity is that this type of investment comes with a high amount of risk. The property that you invest in could do poorly or fail altogether. When this occurs, the debt investors will receive payment before you, which reduces the possibility that you will get back the money that you’ve invested. Additionally, if you expect to receive monthly rental payments but find that your renters aren’t making their payments on time or that the property itself is considered to be undesirable for renters, you may not be able to obtain the kind of returns you’re looking for.
While both equity and debt investments have their pros and cons, the investments that you make largely depend on what would be best for your portfolio. When investing in equity for a real estate project, it’s possible that you will receive high returns in the event that the property performs well. As the owner of the property, you will also have direct control over many aspects of how the property performs, which means that it’s possible you could turn around a failing property. If you would rather invest in debt, these are many investments that yield stable returns and can help to diversify your portfolio.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.