As you delve deeper into real estate investing, you begin to weigh the pros and cons for your investments. You hear terminologies such as debt, mezzanine, and equity in conversations, but do you know what they mean?
If you do not already know what these entail, you are not alone. This blog post will break down each investment type and their differences in basic terms. That way you can decide which investment fits your criteria when you are ready to invest.
This is simply when you provide a loan to an operator backed by an asset such as real estate. As an investor, you will receive either fixed or amortized payments. That is, you either receive interest only or interest plus a portion of your principal for your scheduled monthly payments, also known as a mortgage that you may have taken out on your own residence. You will have the option to fund that loan on your own or you can invest in the loan with the crowd – crowdfunding. Your annualized return usually ranges from 8.5% to 12%. Depending on the project, the term can range from a few months to a few years.
This is when you have the security of debt plus a portion of the profits. This investment type is usually collateralized by more than the subject property. Mezzanine loans are typically used to finance the gap between the debt, first mortgage, and the equity that the operator brings to the deal. Your annualized return usually ranges from 13% to 20% and the term usually lasts less than 12 months.
Finally, this is when you participate in the net profits / net losses. It is very similar to stocks. Think of equity as ownership of the asset after all debts associated with that asset are paid off. Once preferred equity is paid out to the other investors, the remaining net profit will be split between equity investors and the investor-operator, with a small fee for the crowdfunding platform or LLC. Your annualized return is usually 20% or more, depending on the risk.
In our opinion, as you continue to gain experience with investing in real estate, diversifying your portfolio in all three investments is the best leverage you can create for yourself. When you begin to diversify your portfolio you have the opportunity to drive out unsystematic risks. In the event of negative performance from one investment, your overall portfolio if diversified will neutralize from the positive performances of the other investments. The first step to building leverage is having more investments. From that point on, you can start looking into the weight of different investments in your portfolio’s allocation.
The only setback as you attempt to build your portfolio is that you may have a limited investment budget. Therefore, investing a small amount such as a $50,000 or $100,000 in each project may be your way to diversify. Another option is to buy shares in a real estate investment fund, this way you have an inexpensive source of diversifying your portfolio. Your options are vast.
Want to learn more about asset allocation and diversifying your portfolio? Here is an awesome article that will help guide you to make the most profitable portfolio. New Investor’s Guide to Asset Allocation.