Real Estate Equity vs Debt Funds

What is a real estate equity fund?

A real estate fund is a type of mutual fund that focuses primarily on investing in securities offered by public real estate companies. It represents a residual interest in the property. A big portion of real estate funds are invested in commercial and corporate properties, although sometimes it may include investing in raw land, apartment’s complexes and or agricultural spaces. The investor stands to gain a lot when the property appreciates or if you are able to negotiate more rent for your property or buildings. However, when things go wrong. Like losing all your tenants and cannot make your mortgage payments, then the mortgagee- who has the priority interest in your property- May foreclose and you will have to forfeit your equity position to satisfy their securities. Losses are almost similar to those of owning stocks.

What is a real estate debt fund?

A real estate debt fund involves lending funds to a purchaser or owner of a real estate. You will then receive periodic interest payments from the power and a security charged against the property in the form of a mortgage. In the end of the mortgage term. The investor will be given back the mortgage principal.

What kinds of real estate does each type of fund invest in?

When investing in real estate debt funds, one will be working as the lender to the property owner or the deal sponsor. The loan will be secured using the property itself and the investor will receive a fixed rate of return that will be determined by the interest rates on the loan an how much they had invested in. with a debt deal, investors are at the bottom of the capital stack. This means that they have priority when it comes to claiming payouts from those properties.
Real estate debt fund has the following advantages:

  1. A short hold time. As debt investors are normally associated with developments projects, this will typically give a shorter holding period compared to equity investments. Basing on the nature of the deal. The hold time may range from between six and twenty four months. This is an advantage for investors who do not want to be tired up to assets for long-term periods.
  2. Low risks. With how the deals are structured, the investors take on fewer risks with debt investments. The property is used to secure the loan. In the event of a default, investors can recoup from their losses through foreclosure
  3. Steady income. A debt investment have a more predictable return and its frequency of payments.

It also has the following disadvantages:

  1. Capped returns. Its major downside is that the returns are limited by the interests rate born by the loan. Thus, investors have to be clear about whether they are willing to sacrifice the potential to earn higher yields in exchange for a more safe option.
  2. Higher fees. While most real estate crowdfunding platforms don’t charge investors anything to create an account and research debt investments there’s usually some type of fee involved to participate in a deal. The crowd-funding platform usually takes a percentage off the top before any interest is paid out, which can eat into your returns. There may also be a separate loan origination fee that is passed on to investors.

Most real estate crowdfunding deals involve equity investments. In this scenario, the investor is a shareholder in a specific property, and their stake is proportionate to the amount they have invested. Returns are realized in the form of a share of the rental income the property generates, less any service fees paid to the crowd-funding platform. Investors may also be paid out a share of any appreciation value if the property is sold.

Real estate equity fund had the following advantages

  • Nil returns caps – It offers a broader horizon in terms of earning potential. You can realize returns of up to 25% annualized returns
  • Tax benefits – One benefit of owning an investment property is being able to deduct certain expenses associated with its ownership, such as depreciation and the costs of repairs. With equity crowd funding, deals are normally structured through an LLC, which is treated as a flow through entity for tax purposes. That means that investors can reap the benefits of the depreciation deduction without having to own property directly
  • Lower fees – Equity investments have the potential to be cheaper where fees are concerned. Rather than paying upfront fees and monthly service fees, investors may pay a single annual fee to maintain their position in the property. The fee is calculated as a percentage of the total amount invested and often runs between 1% and 2%

It also has the following shortcomings:

  • More risk – Equity crowd funding may put more money in investors’ pockets, but it means taking a bigger gamble. Investors are second in line when it comes to receiving a payback on their investment, and if the property fails to live up to its performance expectations, which can easily translate to a loss.
  • Longer hold period – Equity investors are looking at a much longer period compared to debt investors. Hold times can stretch out over five or even ten years, which is an important consideration if you are interested in maintaining a high degree of liquidity in your portfolio.

How does one start investing in real estate equity or debt fund?
Investing in this area which has a very great potential in terms of returns simply involves buying shares in the real estate investment trust (REITs). This is more like buying stocks or buying into a fund. This is more similar to buying shares of a portfolio of properties.