A Short Overview about Debt, Capital Stack and Equity Investments The two main types of investments in commercial real estate financing are equity and debt investments. Prior to making their first investment, it is essential for real estate investors to understand the important difference between the debt investments and equity investments. What is equity investment? Investor becomes a shareholder in the ownership of a property, when he invests in property as an equity investment. High rate of return and a share in the profits of the assets are some of the primary benefits of such type of investment. The share of profit is paid to the investor on the quarterly basis. In addition, investors will be paid a lump sum amount when the commercial property is sold in the future. Depending on the performance of the asset in the market, the equity investor returns will increase or decrease over a period of time. Such types of returns are not capped. Before investment in equity, investors should understand that there is no fixed-term for such investments. What is Debt investment? A loan that is provided to the owner of a property or sponsor with a fixed term and return is known as debt investment. The payback of such investment is secured against the
real estate property of the owners. The returns in such type of investments are paid out on monthly basis to the investor. Major difference between the debt investment and equity investment The rate of return earned in equity investment is more than the rate of returns earned through the debt investment. In addition to this, there will be fixed terms and returns in debt investment. Whereas, there is neither a fixed term nor returns in equity investment. The return earned can be high or low based on the performance of the assets in the market. Brief overview about the difference between the debt and equity investment
What is real estate Capital Stack? Capital stack is a unique combination of debt and equity investment in a real estate asset. the % of each type of debt and equity investments will depend on the level of risk and annual returns expected by the investors.
The Capital Stack is made three sections including Loan Proceeds, Sponsor & Other Investor Equity, and Acquiring Real Estate LLC Equity. 1. Loan Proceeds It will represent the largest portion of investment in the today’s commercial financing market. 2. Sponsor & Other Investor Equity This type of investment will represent 25% of return on average. 3. Acquiring Real Estate LLC Equity The average return of such investments is 12% annually. Equity is associated with the higher cost so it is positioned at the bottom of this table and debt with lower cost is positioned at the top of the table.
The relationship of each investment type is depicted in the capital stack in regards to the given real estate assets, which will be systematically arranged by the level of risk associated with the different types of investments.