The Difference Between Debt vs. Equity Investing?
It’s been over three years since I raised money for my first multifamily deal. During that time, my knowledge about syndication, apartments, and real estate investing in general has grown substantially.
I remember after my first deal, I was talking to other investors and they asked me, “Did you raise debt or equity,” to which I responded, “Um, I just raised money. I have no idea.” I was very green at the time, but through experience, education, and mentorship, I’ve learned the answer to that question, as well as the answers to many more.
Amy Kirsch, who has over 10 years of financial services experiences, currently works for a crowdfunding company and is responsible for handling over a thousand inbound questions a week from inexperienced real estate investors like I once was.
In our recent conversation, when I asked her what types of questions she received, she mentioned that the question, “What is the different between debt and equity?,” was very common.
Equity vs. Debt
“I akin debt to a mortgage like you’d see at a bank,” Amy said. “You’re acting like the bank. You can expect an interest rate payment monthly. It looks like a balloon mortgage, where you can expect a principal after the life of the loan.”
“On the equity side, you look more like a business owner,” Amy explained. “You’re participating in the upside or the downside participation of the property.”
Pros and Cons
The main advantages of debt are lower risks and a steady income. “The debt is secured by a first lien loan, where should something go wrong, we’re able to foreclose on the property.” Also, the debt investor can expect a monthly or quarterly payout at around 8% annually.
The disadvantage of debt, compared to equity, is a cap on returns, which is limited by the rate, or preferred return, of the loan.
For equity, the main advantage is that there is no cap on returns. However, it is riskier than debt. “Should things perform well, you’ll have unlimited upside. Should things go poorly, you will partake in that as well,” Amy said. Depending on the business plan, the equity investor can realize gains on the sale of the property as well.
This is a high level overview of the differences between debt and equity. Debt is similar to being a bank, while equity is similar to being a stakeholder in a business. Debt has less risk and results in consistent payouts, but there is a cap to how much you make. Equity may or may not result in a higher return, depending on the projects performance, which make it more risky.
For more information on the differences, check out this Investopedia article: http://www.investopedia.com/articles/investing/122315/equity-vs-debt-investments-real-estate-crowdfunding.asp
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