Debt or Equity for Your Next Deal?

Mike: Welcome back to the flipnerd.com REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.

Nav: Hey, my name is Nav Athwal. I’m the Founder and CEO of RealtyShares, an online marketplace for real estate investing. I’m really excited to be here today in the REI Classroom to talk to you about whether you should use debt or equity capital for your next real estate project. An exciting topic that I’m looking forward to chatting with you about.

Mike: This REI Classroom real estate lesson is sponsored by uglyopportunities.com.

Nav: Most real estate projects include a combination of both debt and equity so it’s really not an either/or question, but typically how much of each do you want in your project. A typical real estate project, let’s take an apartment building, for example, will have usually 65 to 75% debt capital as part of the cap stack and 25 to 35% of equity capital.

One of the biggest benefits of real estate is the ability to put debt on real estate. What that means is you have less of your own money in the deal and you’re able to generate higher returns as a result. If you look a lever deal, meaning a deal with debt, and an unlevered deal, the same exact deal without debt, the returns both on the IRR and catch on cash perspective you’ll achieve with a levered deal is typically a lot higher than what you’d get on an equity-only deal.

So that’s one of the benefits of debt. If you can get down on your property, you definitely want to try and get that debt because it’ll have higher returns as a result. Now, you also want to be careful about how much leverage you put on the property. Some of the reasons a lot of companies and projects went bankrupt during the last recession was too much leverage. So getting leverage amounts that sometimes would exceed 80% or 85%, which could really impact the ability to meet that debt service coverage ratio in case the market cracks and NOI at the property level drops.

So you want to make sure you have leverage so you can generate higher returns, but not so much that if the NOI drops, in case there is a correction in the overall market that you’re no longer able to pay the interest payments and principal payments that are owed under the debt instrument. Again, I think you really need to consider a healthy balance of both debt and equity for your project when you’re looking to acquire a project.

Now, one thing I will say is a lot of times, the ability to get a loan quickly enough to buy a property may not be a reality. We saw in 2010, ’11, ’12 some properties were being funded or purchased in as little as 10, 15 days and one way to be competitive was to acquire the property in all cash so that you weren’t competing with offers that required financing. That is something sellers really like because it means you’ll be able to close more quickly and without any sort of financing contingency.

What you can always do if you do have a tight time frame in order to provide a competitive bid to a seller is you can always buy that property all cash and always refinance it after the acquisition and pull equity out. Again, I think to respond, it really depends on the specific deal but you do want to typically put both debt and equity both to maximize returns but also to mitigate risk in case there is a correction and there is too much leverage at the property level.

There are a lot of innovative ways in which you can fund your deal with both debt and equity capital. Our platform, RealtyShares, funds both. So you can come to RealtyShares and get both debt and equity capital for a single project or multiple projects. So there are very innovative ways to fund debt and equity capital outside of the traditional models like banks or friends and family.

Mike: HomeVestors, the “We Buy Ugly Houses” folks, is a franchised system of hundreds of real estate investors that have purchased over 65,000 houses. If you’d like to learn more about the most powerful real estate investing system in existence, whether you’re a pro looking to take your business to the next level or whether you have no experience at all, but a burning passion to be successful in real estate investing, please visit flipnerd.com/ugly to learn more.

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