Real estate Debt Funds are aimed mainly at experienced real estate investors, and developers, meaning this article will cater to this demographic. In case you’re a beginner just opting to find out more, do not hesitate to read on as everything will be explained using simple language. On top of that, the article is still applicable as we mainly cover here on what is a Real Estate Debt Fund, and how’s Debt Fund can be useful in raising capital for real estate investors and developers alike.
In the very next section, the first one at that, we’ll explain the term ‘Real Estate Debt Fund’that may not be a familiar one to a wide public, as well as the way it was developed over time to become what it is today. A safe haven for developers of sorts.
We’ll also find out how does a Debt Fund work and how does it generate income, as I’m sure that’s the first thing on everyone’s mind whilst utilizing its services.
The question asked in one of the subheadings, which type of developers turn to Debt Funds for capital, has already been answered in the very first line of this introduction, or the article itself. But a whole section will be given to the explanation of why.
Next, we shall compare real estate Debt Funds to other options for raising capital, primarily equity capital. Finally, we’ll talk about the disadvantages of a Real Estate Debt Fund, or rather what to avoid while dealing with it.
If the above is something you wish to educate yourself more about, read on carefully. And, should this short summary intrigue you, don’t hesitate to research more on this topic or ask a question at the bottom ‘comments’ section. Who knows, perhaps you’re the next developer to turn to a Real Estate Debt Fund for capital.
Let’s define the Real Estate Debt Fund first…
What Is A Real Estate Debt Fund?
A Real Estate Debt Fund offers short-term capital to anyone who wishes to borrow in order to further invest into projects. Most commonly, these projects are real-estate projects, meaning that the majority of the borrowers are either developers or real-estate investors, as mentioned in the introduction of the article.
Projects eligible to be funded through a Real Estate Debt Fund include construction loans, multi-family buildings and industrial buildings, among others.
Real Estate Debt Fund is mainly backed by equity-backed capital, but more about that in for that specified section. In short, borrowers will receive periodic payments to invest into their projects. Though each Debt Fund generally focuses on a specific strategy, such as funding projects or financing certain assets etc.
Let’s leave the disadvantages of the Debt Fund for later. First, let’s focus on some good sides to this. For instance, Debt Funds helps to maintain a balanced portfolio. It’s also safe, meaning that you’ll receive your funds back should something unexpected happen. The fact you’ll receive periodic payments allows a consistent and steady flow of income.
Dept Funds are also great for versatile investors who wish to invest in different types of properties without actually managing them all.
As for the historical development of Real Estate Debt Funds, it’s important to note they’re fairly young. They’d emerged only in 2009, and since have grown to become the very core of numerous investor’s portfolios. It was the financial crisis that caused the reduction in property lending that allowed these new schemes like this one to form.
How Do Real Estate Debt Funds Work?
As mentioned above, Real Estate Debt Funds offer a bridge of sorts that connects developers or real estate agents with short-term capital that’s given to them periodically to invest into their projects.
Developers purchase properties with the intention of flipping them, or developing them, renovating
them and similar, only to sell them later on for a higher price and double their income like that. They can hold onto that property for a short period of time, a few months or so, only until the prices on the market grow and similar. Or they can hold onto it for years and even decades, flipping it and oftentimes living within the walls until they sell it.
To lower the risk, they turn to Real Estate Debt Funds, but we will talk more about the way real estate debt work and how do they generate income in one of the next sections.
For now, the most important thing is to understand what Real Estate Debt Funds are as well as what developers do in order to bind the two together in the continuation of the article.
Which Type Of Developers Turn To Debt Funds For Capital?
The question from this subtitle has already been answered. Just look at the first line under the title.
Experienced real estate agents and developers mainly utilize real Estate Debt Funds. Less commonly by beginner developers or beginner real estate agents, not because they wouldn’t understand or benefit from it (right the contrary, earning a steady, continuous income from a Real Estate Debt Fund sounds quite helpful to me), but because they may not have heard of this term yet, having come to be only in late 2008 to 2009 after the financial crisis.
The reason it’s most commonly used by real estate agents and developers is because it was built for them, for the program is here to lend money and finance projects. And the reason why this method is more beloved than borrowing from traditional lenders is that, unlike traditional lenders, Real Estate Debt Funds have no special requirements for the borrower.
It’s easy for Real Estate Debt Funds to attract borrowers who may not have qualified for a loan from a traditional lender. The reason for not qualifying with a traditional lender might indicate that the borrower has too complex of a financial situation.
The most common Real Estate Debt Fund loans include:
- Bridge loans or lease-up financing,
- Construction loans, and
- Property rehab loans or redevelopment loans.
How Real Estate Debt Fund Differ From Other Options For Raising Capital?
Real Estate Debt Funds are backed up by equity capital, and we’ve already elaborated that in the course of the article. But what is equity capital, and what’s the difference between equity capital and debt capital?
First of all, what is capital?
In this context, capital refers to money that the developer needs to flip a property, and it’s the money that the Real Estate Debt Funds provide them with. Debt capital and equity capital are the two main types of capital, and not every business needs both to stay afloat.
To find out which one is the right one, continue reading…
What Is Debt Capital?
Debt capital is capital borrowed from a bank or any other financial institution. The name of the debt capital comes from the fact that the borrowers take on debt in exchange for funds.
The most common providers of debt capital are, you’ve guessed it, banks. The borrower will receive funding for their project but will have to pay all of it back with interest.
But, we’ve also seen earlier in the article, that it can be possible you aren’t eligible for a loan from the bank, which is when Real Estate Debt Funds come into the picture. They have no specific criteria you have to meet in order to qualify for a loan.
Business owners tend to prefer this type of capital to equity capital as it carries less risk – they don’t have to give up ownership of their business. However, the downside you can easily notice is that it’s hard to acquire, especially for newer businesses.
What Is Equity Capital?
Equity capital is different as it doesn’t require the borrower to take on debt. Instead, the lenders will take on half of the ownership (equity) from the borrower’s business, and the borrowers won’t have to repay the funds.
As risky as it sounds, this is the most popular way of acquiring capital among newer businesses, as it’s hard for them to acquire loans from the bank. They usually pitch in an idea to an investor and hope they like it enough to invest in their company in exchange for equity. However, the obvious disadvantage is having to give up to half of the ownership of your business.
So, which one is the right one for you? The answer to this question depends on answers on following questions:
- Why does the company need additional capital? For using funds might bring the company into even more debt, for example.
- What stage is the company at?
There are several stages of a company, while growth is supposed to be recorded in the first four stages: seed, start-up, first stage, and second stage, established and turnaround.
While neither debt nor equity capital is forbidden at either stage, the more established companies carry less risk, which means they can take a debt loan.
An equity loan is better for start-up companies.
- What’s the company’s financial situation?
If the company needs capital to grow, taking a debt loan might not be the best idea. An equity loan at a Real Estate Debt Fund might be a better idea.
- How much capital is needed?
A small among of short-term capital isn’t beloved by either debt funds or equity funds. On the other hand, a large loan would need to be broken up into smaller stages.
- What impact will financing of this sort have on the ownership and day-to-day functioning of the company? Would the loan limit the day-to-day operations of the company?
For example, equity investors might add some restrictions, including splitting the ownership between the borrower and the lender.
How Real Estate Debt Funds Generate Income?
Real Estate Debt Funds lean on the interests of the capital they lend to generate income. Most commonly, the interest rates the fund charges the borrowers start at +9%, but they change based on how the market is standing.
Payments are monthly, and loans are per agreement. Some additional fees for the borrower to pay in can also be agreed on, and they include:
- Exit fees,
- Service fees,
- Origination fees,
- Extension fees and
- Modification fees.
As for loans, they’re most commonly inside the $5 million to $150 million range, but can be even higher depending on the scope of the business. These loans are paid in shorter amounts over a period of time, commonly over the scope of 1 to 3 years.
The borrower gathers income strictly through these loans over a period of time, meaning the higher interest rate means more profit. The lender’s goal, however, is to maximize the capital’s disposition value.
If these numbers caught your attention, the first step to investing into Debt Funds is to find a Debt Fund to request a loan from. As we’ve mentioned already, vastly anyone can qualify for a Real Estate Debt Fund, and alongside that, it’s relatively a risk-free business venture.
You don’t even have to manage the investments placed in the fund (unless you’re really keen on becoming a manager). Someone else will do that instead.
What To Avoid?
Some advantages of the Real Estate Debt Fund have already been heavily highlighted. There is little to no risk involved, continuous and constant payouts, and no to minimum requirements to meet, making them perfect for smaller and newer companies.
What are the risks though?
Firstly, little to no risk doesn’t necessarily mean risk-free. Some of the risks also go to the investor; for example, the borrower might flake and it’s hard for the investor to recuperate the invested capital.
What’s also important is to get paired with a good manager, as they’re the ones who’ll be managing all the funds instead of you. You’d want someone trustworthy and professional. Make sure to research their history and do a background check.
It is your decision to make whether you want to invest into a Real Estate Debt Fund. The ratio of benefits versus disadvantages looks pretty promising to me, though. However, at the end, numbers should stack up!
A Real Estate Debt Fund offers short-term capital to developers and experiences real estate agents to further invest into projects. Projects eligible to be funded through a Real Estate Debt Fund include construction loans, multi-family buildings and industrial buildings, among others.
Debt Funds emerged during the 2008-2009 financial crisis and have since become the core of numerous investor’s portfolios.
Real Estate Debt Funds are mainly utilized by experienced real estate agents and developers. Developers purchase properties with the intention of flipping them, or developing them, renovating them and similar, only to sell them later on for a higher price and double their income like that.
Debt Funds are the bridge connecting them to short-term capital to help them with their plans. Real Estate Debt Funds lean on the interests of the capital they lend to generate income, starting at +9%. The loans of $5 million to $150 million are paid in shorter amounts over a period of time, commonly over the scope of 1 to 3 years.
That does not mean start-up companies cannot benefit from Real Estate Debt Funds (they very much can), it just means they perhaps haven’t heard of them. There is little to no risk involved, continuous and constant payouts, and none to few requirements to meet, making them perfect for smaller and newer companies.