An investment in a Real Estate project listed on CrowdfundUP may be in the form of either Debt or Equity in a Company or Trust (which hold the underlying property assets). Globally, approximately 80% of crowdfunded Real Estate projects are structured as equity and 20% as debt investments. In this blog we consider the differences, advantages and disadvantages of each form of investment.
Equity is another term for ownership, so an equity investor is a part owner in the Company which holds the Real Estate assets. A debt investor, on the other hand, is a lender to the Company.
The risks and returns of Equity investment compared to Debt investment are therefore very different.
A debt investor earns interest income only, and at the conclusion of the project, the return of their capital. The total return on a debt investor is limited (or capped) to the original debt, plus the agreed rate of interest during the term of the investment.
An equity investor, on the other hand, is entitled to a share of the capital gains and any income from the project after debt and interest has been repaid. The potential return to an equity investor is unlimited:the more successful the project the greater the return, without any cap.
The trade off for return is a risk. Broadly speaking, equity investors carry a higher risk, coupled with higher potential returns, and vice versa.
A debt investment carries a lower risk profile, as in most cases the debt will be secured by the Real Estate assets themselves. If the project fails the property may be foreclosed and debt repaid (or a portion at least) from the proceeds from selling the assets.
Equity, however, is generally not secured in any way, so the risk profile and potential loss is higher.
Remember, in the event that a project fails, debts must be fully paid out before any return is made to equity investors.
While each individual project will vary, debt investments are usually structured for a shorter term, when compared to equity investments.
For example, in the case of an apartment development, debt funds may be required initially to purchase the property and pay for construction costs, but then are repaid through pre-sales and early sales. Equity investors on the other hand usually have to wait until the development has been fully sold before capital gains and any income are distributed.
The decision to participate either as a debt or equity investor is very much a matter of individual investment objectives and risk tolerance. Those investors that are seeking higher returns should consider equity investments but must also recognise the higher risk associated. Income oriented investors with a lower risk appetite are more likely to be suited to debt investments.
"Any advice provided on this blog is general in nature. Readers are urged to seek their own professional advice before making decisions."