Equity vs. Debt Investment – What is Better?
Real estate is one of the most attractive forms of investment, and it’s no wonder why. When you include residential, industrial, and other phases of real estate, the inflowing funds reach a whopping $165 billion in Q2 2022. And considering the 10-year anniversary of the last real estate market crash is in 2026, we’re overdue for another surge. So, now is the time to get your piece of the pie. But where do you start?
The two most famous forms of funding in the real estate sector are equity and debt funding. Equity funding comes from the owner’s investment, while debt funding is a loan that must be repaid with interest. Both have their own advantages and disadvantages, so it’s important to understand everything about equity vs debt investment before choosing which one is right for you.
Read on to find out the process of funding, the risks involved, the return on investment, and which investment route is right for you.
What is equity investment?
An equity investor will fund or provide money to buy/construct a property, usually to someone who cannot afford the full price. So, this makes him a shareholder or part owner of the property. Whatever revenue that the property is generating in the form of rents, total sale value (or capital appreciation), a portion of it will go to the equity investor. The amount that is owed to the equity investor is directly proportional to the amount that he had invested in the beginning. You can get your money on a monthly, quarterly, or even annual basis.
Equity investment advantages
- Irrespective of your principal investment, if there is an increase in property prices, you will get more returns (Capital Appreciation and Dividends).
- Equity investment is profitable because it takes less time to reap what you sow.
- The rental income will fill your pockets for a long time if the market is in swing and the property is in demand.
- The fee involved in equity investment is usually lower than in debt investment.
- There is no uncertainty and anxiety about unknown upfront investment time.
Equity investment disadvantages
- There are a few projects that will make equity investors wait for returns. This duration can be 5 years or more. Longer wait time implies reduced liquidity
- If you look at it as equity vs debt investment, more risks are involved here.
- If there is a delay or loss in a real estate venture, the equity investors will be compensated only in the end.
What is debt investment?
In debt investment, you are not funding the project itself but lending your money in the form of a loan. The interest rates will apply to this amount. You can pool up with other debt investors to give a loan to a person starting a project or planning to buy a property. There is a minimum hold period during which the borrower will pay you back at regular intervals. The interest will be calculated based on your initial principal funding, and it is your major ROI. If the borrower fails to pay back, his project or property is going to serve as collateral. It is evident that the risk reduces by more than half compared to equity investments.
Debt investment advantages
- People who make debt investments do not have to worry about high risks. This aspect is an advantage in the equity v/s debt investment comparison.
- There is high liquidity if the amount is small and the term is less.
- There is regular, usually monthly, income to the investor.
- The property is the collateral, so sometimes you can be lucky and not lose even a penny from what you had invested.
- In certain agreements, you get to choose your interest rates.
Debt investment disadvantages
- Unlike equity funding, you will not get the profits from the sale or rental amount. You are not eligible for credit appreciation or dividends.
- The ROI is lower unless you loan the entire amount needed for the project.
- The fee is usually high.
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Equity Investment vs Debt Investment – What should you choose?
Choosing between equity vs debt investment depends on your personal preferences. In most cases, it is also closely associated with the investment strategy. These are certain factors that can influence your decision –
Your foothold: You are part of the project in equity investment. You are one of the owners and your input/advice/suggestions matter. As an investor, you have a say in what happens. In debt investment, you are only lending the money and have no say in the course of the project or getting any profits later on.
The risk involved and your tolerance: Equity investment has higher risk because there is no collateral, and these investors get paid in the end. On the other hand, debt investments are predictable, and there is regular payment. In case of losses, these people get paid first. If you want to avoid high risks, debt investment is the one for you.
Returns: When there is a higher risk, the rewards are juicy! Equity investment has uncertainty looming over it. But when you hit the bull’s eye, the profits are very satisfying. In debt investment, there are lesser profits in comparison to equity.
Holding time: Liquidity is the main thing to consider. Equity investments usually span for a long time. This duration can be ten years or more in some cases. Debt investment is short-term funding that comes with high liquidity. This liquidity is almost absent with equity.
Legal fee: The State Laws and Legal Tax Rules will differ from country to country. Equity investments are liable for taxes sooner than debt Investments. But you will have to pay higher fees for debt investment than equity. This fee will depend on the gain time and the amount earned.
The Final Verdict
The winner in the battle of equity vs debt investment depends upon the person who is investing. If you are someone who prefers lesser risks and a smooth investment route, debt is for you. People who are not against the idea of risk and like to pocket more profits will prefer equity investment.
An even better approach will be to go with a mix of both. This approach will help you improve your investment portfolio and explore diverse options. Even if you lose from one, you can gain from the other one. You get a sense of stability and earn more than what you would by investing only in one of the two options.
Fortunately, we live in a day and age where information is readily available at our fingertips – which means there’s no excuse not to do your homework before diving headfirst into this incredible opportunity.
Need help? Schedule a free consultation at LBC Capital and happy investing!