A Balanced Debt and Equity Investment in Real Estate

By: Andrew McShane

A Balanced Debt and Equity Investment Could Provide better returns than Stocks. Here is how to Build a Balance of Both.

You are about to learn...

  • The Difference between Investing in Debt or Equity
  • How to Invest in a Balance of Both Debt and Equity
  • Is a Debt or Equity Investment Right for You?

Even though the Real estate market took a hit this year, Real Estate investing is still big business with more than 45 million rental units in the United States. As investors, there are two major reasons to remain optimistic about the real estate market. This is true for both a debt investment and an equity investment.

For one, the National Association of Home Builders/Wells Fargo Market Index, which asks its members to rate the conditions for the sale of new homes at the present time and in the next six months, as well as traffic of prospective buyers, has reached an all time high in Nov. 2020, after bottoming out in April.

A balanced debt and equity investment
NAHB Housing Index

The rise in this index could be due to multiple reasons but a major reason could be the desire for more space due to the pandemic and the huge rise in demand for single-family homes in the suburbs.

Another reason for optimism in real estate investing is the amazing growth in online real estate apps, providing investors with the opportunity to create a real estate investment portfolio from the comfort of their own home.

No longer do investors have to be on-site to check out a potential real estate investment. Apps like Fundrise, RoofStock, and YieldStreet make investing in real estate easier than ever before.

The question now becomes, “Do you invest in debt, invest in equity or both?”

A Debt Investment vs. Equity Investment

Real estate equity crowdfunding and crowdfunding of real estate loans could be lucrative for an investor if they take the right approach.

Prior to 2016 if you wanted to make an equity investment or a debt investment in certain private real estate transactions you needed to prove certain personal financial criteria. With the new legislation, smaller investors are now allowed to make a real estate investment through crowdfunding that was never previously possible.

Now with crowdfunding real estate loans and equity you are able to invest a relatively small amount in certain large private transactions that previously would have been off limits.

With a crowdfunding equity investment, you are a partial owner, and the management team is required to disclose to you certain information about the health of the business from time to time. This allows the investor to track the progress of their investment to help assure things are going well.

With a crowdfunding debt investment, you own a piece of the debt financing that will normally be secured by the assets of the business.

The Traditional ways to Invest in Real Estate

The more traditional ways to invest in real estate is to either buy shares of a publicly held real estate investment trust (REIT) or to buy property directly and be a landlord.

The advantages of a REIT is that the shares are very liquid and can be traded in the stock market daily. Publicly held REITs tend to be a good-sized company that are diversified and can absorb the impact of changing economic dynamics. If you pick the right publicly held REITs you can get a 4% annual return via dividend/distribution payments, plus some appreciation on your share price. This equates to a total annual return in the 8 to 10% range.

The advantage of being a landlord is that you are essentially a small business owner, selecting the properties you want to invest in and then managing those properties like a small business owner. This requires you to make sure the property presents itself well and that you screen the tenants in advance to make sure the rents are paid in a timely fashion.

A good rate of return from being a landlord is 10% or more, so that should be your target

The disadvantage of being a landlord is that your investment is not very liquid, likely taking at least weeks to buy and sell specific properties.

Crowdfunding Investment in Real Estate

Real estate equity crowdfunding and crowdfunding of real estate loans are an up and coming way to participate in the advantage of real estate without many of the disadvantages.

There are many real estate crowdfunding platforms that bring project sponsors and investors together. One of them that we will use here as an example is RealCrowd based in Palo Alto, California. Their mission is “to transform the real estate crowdfunding industry by giving investors the same direct and free access to commercial real estate that institutions, pension fund and university endowments have always had”.

Real Crowd describes itself as “a marketplace where sponsors can list their offerings and investors can typically invest between $25,000 and $1 million per investment to own their pro-rata share of that deal”.

With real estate crowdfunding platforms like RealCrowd you can view the projects that are available for investment on their website, perform your due diligence by reviewing the project prospectus and decide what, if any, real estate deals you want to invest in.

Keep in mind that the information present on these real estate crowdfunding platforms are only offers to sell, so you need to carefully evaluate the risk of any project before making any investment.

The advantage to crowdfunding is that you will get the ability to invest small amounts in different projects that would otherwise not be available to you. The returns on these projects could approach or exceed 20%, so they are attractive to real estate investors.

The disadvantages to crowdfunding are that you are investing for the long run because you will not be able to get your money out of these projects quickly. So be sure to invest only investment funds that you do not need for the next several years. And like any real estate project there is a risk that you may lose some or all of your investment, so be sure to invest no more than 10% or 20% of your net worth in these kinds of deals.

Is a debt investment or an equity investment in real estate right for me?

Investments in equity and debt for real estate presents a dilemma sometimes when it comes to figuring out which investment opportunity is right for you.

The advantage of a debt investment is that your investment stands ahead of the equity investors. This does not mean that your investment will be successful, it just means that you will get paid before the equity investors.

The disadvantage of a debt investment is that you do not participate in the upside if a project is successful. With debt your investment return is capped at the amount of the interest payments plus the return of your investment.

The advantage and disadvantage of an equity investment has to do with the risk to your investment dollars. If the project is successful you participate in the upside, which could be substantial. However, if the project fails your equity investment only gets returned once all the debt holders are paid in full.

In Summary

Investing part of your portfolio in real estate is the right thing to do for many investors.

Crowdfunding is a relatively new concept that allows individual investors to participate in certain projects that previously were off limits.

Investing in real estate through both debt and equity transactions can both be rewarding for investors depending on their individual financial goals.

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