As an investor you should be aware of the differences between debt and equity investing for delivery of good return. Examples of debt investment are bonds and mortgage whereas equity comes in the form of stocks. What happens in case of debt instruments is that instead of procuring commercial bank loan, the organization “borrows” from investors. Owning stock means being the owner of the organization where the number of shares owned determine the percentage of ownership. In the case of property investment, with debt investment you are acting as a lender to the property owner whereas in case of equity you hold an equity interest in the ownership of the property.
In this article we are going to elaborate more on these two types of investments.
Who gets what?
In the case of debt investment, you can claim for fixed interest payments only whereas in the case of equity investment you receive share of net profit. What does this mean in real life? Your risk is much less with debt investment due to fixed interest rate. Your yield is tied up to the interest of the loan only.
With equity investment you have no cap on return. Your annualized returns may range from 18% to 25%. However, the potential of risk is much higher. You may make a fortune or lose a fortune. Your gains are determined by the type of transaction and market volatility. Your share value may fluctuate with the market. Even major economic or political development may have impact on your share value. In other words, you are taking higher risks of loss in return for higher potential reward.
Who gets the money first?
With debt investment the investor has priority when it comes to claiming a payout to the property, i.e., you get your part before anyone gets anything. In the case of equity investment, you get your share after everyone gets their own part.
Another advantage of debt investment is that it is backed up with collateral. In case of default of a property owner or sponsor, debt investment may be recouped through foreclosure. In case of equity investment, you are the owner of the investment and face the consequences accordingly.
Another issue to consider is the hold period. Equity investment can stretch out over five or even ten years whereas the hold time of debt investment is much shorter. The issue is whether you want your money to tide up to a property or whether you want to maintain a high degree of liquidity of your portfolio.
What to choose?
Your choice may be determined by your investment goals. If you are seeking striking growth or profit potential, equity investment is a go. However, if you are after lower but more consistent return, debt investment is a better option. In other words, your investment preferences and risk tolerance are factors that will determine your choice. Your preference of debt investment over equity investment actually means making safer bet with the sacrifice of higher yields.