A real estate debt fund allows borrowers to obtain short-term capital for a variety of different commercial real estate projects, which means that the borrowers are almost always developers or experienced real estate investors. The types of real estate projects that are able to be invested in through a real estate debt fund include construction loans, multi-family buildings and industrial buildings to name a few.
A standard real estate debt fund is comprised of equity-backed capital that can be lent to real estate asset owners as well as potential buyers of real estate. Anyone who invests in this type of fund will generally receive periodic payments from the interest charged against the capital as well as security that’s charged against assets of a property. Each debt fund is usually centered around a specific investment strategy. For instance, some funds will focus on financing certain asset types. Before you get started with this type of investing, it’s important that you’re aware of what real estate debt funds entail.
How to Generate Income Through Real Estate Debt Funds
If you decide to invest your money into a real estate debt fund, you will be able to generate most of your income from interest that’s gathered on borrowed capital, which means that a higher interest rate will allow you to garner more income from the investment. Some of the income that you generate can occur in the event of a default, which will allow the fund to obtain the title to the collateral that was used as the basis for the loan. If your investment allowed a developer to construct a commercial building, this property would be available to the fund if the borrower defaulted on their monthly payments.
These funds typically charge interest rates of at least nine percent, which can differ depending on the current state of the market. These rates are usually fixed with a requirement that monthly payments are made on them. The borrower of this loan must also pay some additional fees, which can include:
- Exit fees
- Servicing fees
- Origination fees
- Extension fees
- Modification fees
While it depends somewhat on the exact type of real estate debt fund you invest in, there are times when investors are given some or all of the fees that the borrower is required to pay. .
If you want to start investing in real estate debt funds, your first goal should be to find a debt fund, of which there are many to select from. Unless you want to become a manager of a debt fund, someone else will manage all of the investments that are placed in the fund, which gives you the ability to sit back and collect your payments.
This form of investment is useful if you’re looking to have a balanced investment portfolio. Investing in a real estate debt fund is a relatively low-risk investment, which gives you an opportunity to lower the risk of your investment portfolio and provide yourself with consistent income while you wait for your riskier investments to pan out. If you invest solely in risky investments, your losses could be substantial. Investing in a real estate debt fund can be a way to hedge these losses.
How Debt Differs From Equity
Before you go forward with investing in a real estate debt fund, you should first know how debt differs from equity. If you have a greater appetite for risk, investing in equity is likely a good option for you. When you make this kind of investment, you will have either full or partial ownership of the property in question. While individuals who invest in equity will be paid last in the event of the project failing, the potential for high returns is better when compared to someone who invests in debt on a property.
The focus of investing in debt is to minimize risk whenever possible. In most cases, debt investors will minimize risk while increasing the possibility of obtaining a fixed rate of return. Even though the potential for high returns is greater with equity investors, debt investors generally benefit from receiving consistent payments. A debt investor also holds the collateral for the loan, which they can claim in the event that the borrower defaults.
Who Invests in Real Estate Debt Funds?
Debt funds are able to provide commercial real estate borrowers with loans and terms that they can’t receive from traditional lenders. The problem with borrowing from traditional lenders is that they usually have very strict requirements that a borrower must meet if they want to borrow any amount of money. If a borrower is unable to qualify for a loan from a traditional lender, or they seek speed in closing, they can seek investments from debt funds instead.
If a borrower has a somewhat complicated financial situation or lower credit than is usual, they can look towards real estate debt funds for their project. The common loan types that are available through real estate debt funds include bridge loans, construction loans, and rehab loans.
How are Bridge Loans related to Real Estate Debt Investing?
A bridge loan is a type of loan that borrowers can seek if they require short-term financing until they are able to secure more permanent financing. For instance, borrowers who are in the process of selling their current property can purchase another property with a bridge loan.
Once the current property has finally sold, the money that you receive from the sale can be used to repay the bridge loan or to convert it into a standard mortgage. As an investor, your money can be used to invest in a bridge loan through a real estate debt fund. Construction loans and rehab loans are two additional loan types that debt funds may invest in.
Almost any type of investor can choose to invest in a real estate debt fund. Since these funds collect contributions from a large number of investors, your contribution can be any amount that you would like it to be, which can correlate with the amount of risk that you would like to take on with your investment portfolio. If you’re thinking about putting some of your money towards this type of investment, you should know about the pros and cons associated with doing so.
Benefits of Investing In a Real Estate Debt Fund
There are many reasons why you might want to invest in a real estate debt fund, the primary of which is that these investments typically provide stable returns and consistent payments. Whether you’re attempting to balance a high-risk investment or are currently sticking with low-risk ones, a real estate debt fund makes for a good investment opportunity as long as you partner with the right fund management firm. Keep in mind that the payments you receive are usually provided on a monthly or quarterly basis.
Investing in a real estate debt fund also provides you with security within the capital stack. This is a form of senior debt, which means that your investment will have first priority when compared to all other types of investment for the property in question. This is a useful way to diversify your portfolio and helps to minimize risk. Debt funds invest capital into many different projects at a time, which is another avenue for diversification. Since your money is spread around to numerous projects, the failure of one project shouldn’t cause you to lose a substantial sum of money.
Downsides to Consider When Investing in Real Estate Debt Funds
Even though real estate debt funds generally come with lower risk and are able to provide consistent returns, there are some downsides to using your money for this type of investment. Although your risk is mitigated, there is still some risk of investing in a real estate debt fund. For instance, there’s always a possibility that a borrower defaults on one of the properties that you invest in. While the debt fund manager will be able to take control of this property, it may be difficult to recoup the money you’ve invested in if the commercial real estate market in the surrounding area is performing poorly.
When investing in a real estate debt fund, it’s also important that you pair with the right debt fund managers. Make sure that you read up on the history of debt funds before you invest in one. While there are some downsides to investing in a real estate debt fund, the relatively low amount of risk vs possible rewards makes this a good option.
Real Estate Debt Funds: Minimized Risk with High Returns
Investing in a real estate debt fund gives you the ability to maintain a balanced portfolio. These debt funds are backed up by collateral, which means that in most cases you’ll be able to get back some of your investment if the borrower defaults. While equity investments may give you the possibility of a higher return, investing in a debt fund allows you to receive monthly or quarterly payments for a consistent generation of income. If you want to invest in many different types of real estate without needing to actively manage the property that you invest in, a real estate debt fund may be a good option for you and your portfolio.
Before you get started with investing in a real estate debt fund, you should first look at all of your options when it comes to real estate investing. Unlike many investment types, real estate investments can be very exciting because of the variety and potential returns that they provide. Whether you want to maintain a high-risk or low-risk investment portfolio, both of these investment strategies are possible with commercial real estate investing.
*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.