Keywords: real estate crowdfunding; types of investments; equity investments; preferred equity, common equity
There are two main types of real estate crowdfunding investments at the moment, equity investments and debt investments. Investors need to consider several factors when deciding what investments they are going to take on. Usually, they vary in potential returns, liquidity and level of risk they possess.
In the previous article, we explained what debt or loan investments are about. In this one, we are going to take a close look at equity investments, and explain their strengths, and weaknesses, as well as what they mean for investors.
Related: Article: What is Real Estate Crowdfunding?
When investing in equity, investors own a proportional share of a specific real estate project. The return on investment is based on a property's rental income and any change in the value of the property project.
Generally talking, equity investors receive higher returns than debt investors. They also receive regular rental income on a monthly or quarterly basis as well as earning income when the property is sold.
However, equity investments are associated with higher risk and longer holding periods than debt investments. The holding periods can vary between 3 - 10 years or more, which makes them less liquid as well.
Regarding the holding period in equity investments, investors should be careful with the term “Target holding period” (especially for common equity). It basically means that the holding period is only a projection, and there is therefore no assurance over when the investment will be paid out.
(Please note: Some platforms offer secondary trading, where investors can resell their investments. This can reduce the holding period and make investments more liquid)
Investors also need to take into consideration that there are two types of equity investing, common and preferred equity. Both share similarities, yet there are some differences.
Basically, common equity investments are the riskiest investments in real estate crowdfunding. Common equity investors have the lowest priority when a project gets into financial troubles, which means they are the last ones when it comes to payouts.
So if a project doesn’t meet its projected returns, first to get paid are debt lenders (senior and then mezzanine debt investors), then preferred equity investors. And then finally common equity investors receive their share from whatever is left (if anything).
This higher risk level, however, means that they also receive the highest yields out of all real estate crowdfunding investors.
In practice, based on our research, common equity investments tend to offer around 12 - 18% in yields. (although the exact figures may vary)
On top of that, common equity has an uncapped upside on returns. Therefore, if the project is showing great results, those results will be reflected in the investors’ yields.
Although preferred equity retains aspects of equity investing, for example investors become shareholders of a real estate project, there are some differences from common equity.
First of all, preferred equity investors have priority over common equity investors but are still subordinate to all debt lenders. Hence, the level of risk is, in general, smaller than in the case of common equity, but still higher than in comparison to debt investing.
The level of risk is reflected in average yields, which are usually lower than with common equity. The yield range tends to be around 9 - 13%, but again, the exact figures may vary.
Another difference is that preferred equity investors have fixed returns which don’t always reflect the success of a project.
Even though some preferred equity contracts offer an increase in returns, if the project is going well, this increase is always capped. This is different to common equity where the returns are unlimited.
Preferred equity is also often confused with mezzanine debt investments. These two investments share some similarities. From a financial aspect, both offer a similar level of risk and the amount of expected return. The main difference though is in the legal aspect of the contract, but more on this in our next article.
Equity Investments Summary
- High Yields: Equity investments offer high yields in comparison to other types of real estate investments.
- Long Holding Periods: The duration of equity investments is usually between 3 - 10 years or more. So even though investors receive monthly or quarterly payouts, it is less liquid than debt investments and investors have to take this into consideration.
- High Investment Risk: High yields and longer holding periods are associated with a high level of risk. If the property project fails to meet its value expectations, equity investors are the last ones to receive their money back
- Can Be Uncapped: Common equity is usually uncapped and potential returns can be very high if the project is successful, while preferred equity usually has fixed rates, with a capped return
- Taxes: In some markets, equity investments offer certain tax benefits such as if you hold investments long-term, your capital gains tax could be significantly reduced. However, it differs from country to country, so it is recommended for investors to do their research for each country and each platform before investing