Investing in commercial real estate (CRE) can be approached from both a debt and equity perspective.
Here’s a summary followed by a pros and cons list for both:
When you invest in CRE debt, you’re essentially acting as the lender. You provide capital in exchange for periodic interest payments and the eventual return of your principal. The most common form of CRE debt is a mortgage.
When you invest in CRE equity, you’re buying ownership in the property. This means you stand to gain from the property’s appreciation and any rental income, but you also bear the risks of property devaluation and vacancies.
Debt investments typically provide regular interest payments, offering a predictable income stream.
The loan is backed by the property, which can be seized and sold if the borrower defaults.
In the event of a default, senior debt holders are first in line to get paid, reducing the risk of loss.
Debt investments tend to be less volatile than equity investments because they're less affected by property value fluctuations.
The return is limited to the agreed-upon interest rate. Investors won't benefit from significant property appreciation.
If interest rates rise, the value of existing fixed-rate debt can decrease.
If the borrower defaults and the property value has declined, there might be a loss upon selling the collateral.
Some CRE debt instruments may not be easily tradable.
Investors can benefit from both rental income and property appreciation.
Equity investors often have a say in property management decisions, especially if they hold a significant stake.
There are potential tax benefits associated with property depreciation and other real estate-specific deductions.
As property values rise, owners can potentially refinance the property to pull out equity.
Equity investors are last in line to get paid in the event of a default or bankruptcy.
Property values can fluctuate, leading to potential losses.
Owning property can come with management challenges, from dealing with tenants to maintenance issues.
Selling a property or a stake in a property can take time, making equity investments less liquid than some other assets.
The decision to invest in CRE debt vs. equity depends on an investor’s risk tolerance, desired level of involvement, and investment goals. Debt offers more stability and predictable returns but with limited upside. Equity provides the potential for higher returns but comes with increased risks and responsibilities.
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