In this video, I discuss two different structures of financing for passive real estate investors, debt and equity. Each have their pros & cons.
Hi. This is Devin Elder. I want to record a real short video today to talk about debt versus equity investing. When we approach investors, work with investors, there’s basically two kind of structures and they simply fall into usually the debt side, is on the single family, or meaning a house, just a residential house. The equity side is usually on the multi family or the apartment side. I’m going to talk a little bit about the debt investing first.
Debt means that you lend money against a project and you get a set rate of return. It might be 10% annualized return and you might get monthly interest payments, or you may get that all in the back end. Your money that you’re loaning is earning a set amount, just like the bank. If you have a mortgage you might be paying four or five percent interest annually on the money. You send it to the bank every month. That’s how we structure debt investing with our investors where we’ll set a predetermined amount and a predetermined interest rate and we pay the interest rate regardless of what happens with the project, whether it’s wildly profitable on our side, or whether it doesn’t make that much profit. The investor still makes their set interest payment, which is good and bad.
It’s good because you can count on it and you don’t have to worry about the performance of the project necessarily or what the profit margins are. You’re just going to get your check and it’s a set amount and if you’re happy with that that works out great.
The downside of debt investing is that if it is wildly successful you don’t participate in any of that because you don’t have any equity in it. Pros and cons of both.
On the equity side, we typically structure the multi family or the apartment complex side with equity where we’re getting a bank loan for a large majority or alliance share of the capital and then we’re pooling investors together and putting in our own capital to do something called a syndication where we’re basically everybody’s a fractional owner and they have equity. Equity, good and bad as well. Equity’s good because you are a fractional owner in that apartment in that entire project. If the project does well and hits it’s numbers then you get a benefit from being an owner in that project. While we set projections against all on multi family side, those are actually tied to the performance of the project when you’re an equity owner.
One of the things that happens a lot of times that you’ll see with an equity structure is a preferred return, so that is nice for a passive investor. That means that preferred return is getting paid first before any other expenses are paid out to the management team. Basically me as a sponsor or my company as a sponsor leading a deal, a multi family or apartment deal, that preferred return gets paid first before of the asset management fees or some other things. Basically the passive investor’s getting paid before the sponsor’s getting paid.
The preferred return acts as a nice way to kind of regulate your cashflow and have a reasonable guarantee that those payments are going to come in, even though you are participating as an equity loan. A preferred return basically says the investor gets paid first and then after that the rest of the asset management fees and things like that get paid out of the profit of the deal.
That’s a quick look at debt versus equity investing. Again, each have their pros and cons, but I wanted to kind of spell that out because I’ve gotten a few questions on it. Thank you.