Real estate structure, investment opportunities presented on the CrowdfundUP platform may be in the form of Debt or Equity. Some investing in commercial real estate projects may be a combination of both. In this blog we explore why this is the case, and what difference it makes.
Real Estate transactions (whether for investment or construction) are usually financed with a mixture of equity (the ownership interest) and debt (borrowings). The composition of the equity and debt is known as the "capital structure" or the "capital stack".
The importance of the capital structure is that each component of the structure will have different risk and return characteristics. We have presented a typical structure below:
Equity represents the "ownership" in the property or project. Equity does not carry a defined rate of return or interest, or have a defined term. Any debt (and interest) which "underpins" the equity must be paid out before equity is returned. For this reason, equity carries the most risk. The trade off for the risk of the investment is the return: equity does not have a defined rate of return, however, the potential return is uncapped, so the more successful the project is, the greater the return to the equity holders.The equity component of a Real Estate project usually comprises 5% to 20% of the total funding.
One variation that is relatively common is a second type of equity known as "preferred" or "preference" equity.Preferred equity includes enhancements as an incentive to invest and lower the overall risk. These enhancements include a defined rate of interest, but as a tradeoff there may be limitations on the participation in the project returns (unlike equity, which is uncapped).
Mezzanine (or "junior") debt is the next level of funding after equity. This debt is usually provided by specialist institutions, and possibly Banks (though this is uncommon).Mezzanine debt makes up the shortfall between equity and Senior debt (see below).Mezzanine debt carries a defined rate of interest (10% to 15%) to compensate for the elevated risk. While Mezzanine debt may be secured, the risk is higher as Mezzanine debt interest and capital is only paid afterSenior debt obligations are satisfied.Mezzanine debt will usually have a fixed term of 12 months to 2 years.
Senior debt (or "first") usually makes up the largest component of overall funding: between 60% and 80%, and is most often provided by Banks.
The term "Senior" means that the debt and interest must be repaid before any other debt or equity can be repaid. In addition, Senior debt is secured by the Real Estate assets; so even if there is a shortfall in the project, Senior debt may be repaid in full, while losses are incurred by Mezzanine debt and equity holders.
Because of the low risk profile, Senior debt earns the lowest rate of interest (5% to 8%).
Senior debt usually has a fixed term of 12 months to 3 years.
Every Real Estate project is unique, and the capital structure will also be different for each project listed on CrowdfundUP (so you may see additional variations to those described in this blog).
As an Investor, it's essential to fully understand the type of investment that you are considering, the potential returns, and the associated risks. Always ensure that you only invest in projects that are suited to your individual circumstances and risk tolerance.
"Any advice provided on this blog is general in nature. Readers are urged to seek their own professional advice before making decisions."