Debt Vs Equity Investing

Real estate investments can be done in two broad categories: debt and equity.

Debt

An investor lends money to the borrower as a real estate loan. For this, the investor earns income for the duration of the loan - usually at a fixed rate following a schedule of regular interest payments on the loan principal.

Such investments, also known as "debt investment" is typically less risky than equity investments. Debt holders have the highest priority of repayment. They receive their principal plus interest before an equity investor can realize any returns. For example, if a home owner sells their property while there is a loan, they must repay that loan in full to the lender before they are able to keep any returns from the appreciation for themselves.

Equity

An investor gets ownership of a physical property. They are also entitled to earn regular income from rental payments for the lifetime of the investment and a claim on money earned from any appreciation earned by the asset when it is sold.

Such investments, also known as "equity investment" are often riskier than debt investments. Equity holders have the ability to earn rental income that can change over time in relation to market demand. Income potential is also based on occupancy rates, which can also vary for any given property. This means that equity investors have the potential to earn a higher rate of return. Common equity investments can last indefinitely, giving an investor the ability to earn income until the property is sold. Remaining distributions of cash flow are returned to common equity holders. Investors seeking a higher yielding, but steady return, may invest in preferred equity.

Active Vs Passive Investing

Real estate Investments can also be active and passive.

Active

Active investing requires financial acumen, negotiation skills, hands-on management of responsibilities and a deep understanding of how to invest in real estate - including construction, repair, fund raising, tenant search, accounting, rent/debt collection, eviction, knowledge of local laws etc. Active investors shoulder quite a bit of responsibility in ensuring the success of an investment property to improve their cap rate and overall return on investment.

Passive

Passive investing offers opportunities to invest in real estate for everyone: those with extensive real estate and financial knowledge and those with limited or no expertise. Passive investors typically provide capital and allow professionals to invest in real estate on their behalf. In general, passive real estate investments offer a greater potential for passive income than most active real estate investments, which typically require more hands-on management.