After explaining what is real estate crowdfunding, how it works and what benefits it brings over traditional real estate investing, let’s delve deeper and explore what types of real estate crowdfunding are on the market.
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 it. Usually, they vary in potential returns, liquidity and level of risk they possess.
Related: Article: Real Estate Crowdfunding: Equity Investments
In this article, we are going to focus on debt/loan investments and explain what are their strengths and weaknesses, and what they mean for investors.
Probably the most common type of real estate online investments are debt/loan investments. In this case, investors act as lenders to the property owner, investing in a loan associated with the respective property project.
The holding periods for debt investments are relatively short and usually vary between 6 - 24 months, which makes debt investments pretty liquid on the real estate investing scale. During the period, investors receive a fixed interest on a regular basis.
Talking about the risk and yields associated with this type of investing, we have to divide debt/loan investing into two types: Senior debt and Mezzanine debt.
Senior debt is the first source of money that property developers and sponsors are reaching for when funding a project. Senior debt owners have priority over mezzanine debt owners and equity holders when a project should get into financial problems. Because of this priority, which means higher security, senior debt offers a lower return rate. This usually varies between 3 - 8%, hence it’s the cheapest way to fund a project for developers and sponsors.
Senior debt owners seek security for their investment. For this reason, senior debts usually cover 50 - 80% of a project's funding needs, followed by mezzanine and equity funding.
From the investor's point of view, the low return rate is balanced with a low level of risk. In fact, senior debts are seen as the safest investments in real estate crowdfunding. This means, if something goes wrong with a project, senior debt investors will be first in the line to get their money back.
For instance, banks are very often in the position of being senior debt lenders. However, some real estate crowdfunding platforms offer senior debt projects as well.
Think of mezzanine debt as a bridge between debt and equity investments. Investors stand in the payout line behind senior debt investors - but have priority over equity investors.
This makes mezzanine investments riskier, so the return rate tends to be higher and can vary between 9 - 15%.
From a financial aspect, besides higher returns associated with higher risk, mezzanine debt offers short holding periods and fixed returns with monthly or quarterly interest, similar to senior debt investments.
It can also be often confused with preferred equity investments. These two types are very similar to each other, especially from a financial point of view. The difference is mainly regarding the legal aspect, but we are going to discuss this in our next articles.
Debt/Loan Investments Summary
- Safe: Debt investments offer lower risk level, with senior debts being the safest investments in the real estate crowdfunding world
- Short holding period: The holding period usually lasts between 6 - 24 months with fixed monthly or quarterly interest
- Capped interest rate: Since returns in this type of investing are in the form of interest, investors receive a fixed regular monthly/quarterly income, no matter how profitable a project is
- Steady income: Short holding periods with capped interest rates generate a great steady and predictable income for investors
- Lower returns: Lower investment risk combined with capped interest and a short holding period may naturally lead to lower returns