Understanding Debt vs Equity Investment in Real Estate

Speaking things off is our first speaker, Chris Ellingham, Business Development Manager at Australian Integrity Investments.

Chris has over 15 years of experience in finance and investments and today he'll guide us through debt versus equity investment in real estate.

Please welcome Chris.

Thanks Angelina.

Yeah, so I'm going to be talking about the difference between debt and equity investment in real estate, and then giving a bit of information about the Quantum Leap Alternative Credit Fund, which is the fund which we are the investment manager for.

So debt investment involves lending money to a property owner or developer.

Investors can earn returns through fixed interest payments,

which are typically secured against the property itself, which offers protection in case it does go into default.

Equity investment.

This is where investors acquire ownership, either wholly or partly in a particular property.

Returns are generated through the rise or fall in the property price, as well as rental income.

It's got higher potential returns, but there's higher risks involved compared to debt investments.

The key differences between debt and equity investments, firstly, there's the risk profile.

Debt is generally got fixed returns and it's got security linked to the loan.

Equity investments are higher risk due to the market volatility and the dependence on the particular property itself.

Returns for debt are generally steady and predictable as the interest is fixed and defined before the money is loaned to the borrower.

Equity investment has potential for higher returns as it can have capital gains, but there's also potential for losses depending on what happens with the property.

And the third key difference is the investment horizon.

Debt investments are typically shorter, between one and five years, and even in some instances with some of our loans that we do, they can be a couple of months.

Equity investments are generally longer term, five plus years, and the capital is very difficult to get out of if you do need to sell the property quickly.

So what is a real estate debt fund?

It's a managed investment scheme that's operated under an FSL that lends money to real estate owners or developers for projects.

And the returns are earned through interest payments from each of those loans.

This provides steady income for the investors.

It's lower risk, as I previously mentioned, compared to equity since debt holders are repaid before equity.

And real estate debt funds generally invest in real estate debt products such as mortgages, mezzanine loans and bridging loans.

The benefits investing in real estate debt funds, there's the stability of returns, as I mentioned previously, the terms of the lending are set out before the money is lent to the borrower.

it'll all be predefined and you can be aware of what's going to be happening over the next 12 months, for example.

It's lower risk compared to equity investing.

As the picture on the right shows, the debt investment will only cover, for example, up to 65% of the loan of the property and is repaid before any equity.

So it would need quite a large decrease in the value of a property for any losses to be made.

Another key benefit is diversification.

Funds can hold multiple mortgages, so could be held in different types of lending, for example, retail, commercial, residential, could be development, could be land, as well as different areas.

Primarily our fund invests in or lends in metro areas in Melbourne, Sydney and Brisbane, but there is the option to lend to borrowers in more regional locations, but it's assessed on a case by case basis.

Also another benefit is the shorter investment horizon.

So investments can be from a year upwards and generally the funds are accessible far quicker than an equity investment.

So real estate debt funds provide higher returns with lower volatility than other asset classes.

So the current term deposit rate is about 4%, which is lower volatility than real estate debt funds, but with much lower returns.

Equities can have, you know,

pretty high years of returns, but there's also, here's where they could be losses, for example.

Whereas, you know, the real estate, the Quantum Leap Alternative Credit Fund has a far more smooth return to investors with less volatility and a target return of over 10%.

So who should invest in real estate debt funds?

Primarily it's people with aversion to risk.

So it's ideal for people seeking a steady income with lower risk than equity investments, for example.

And for people that are also prioritising regular income over capital appreciation.

And as I previously mentioned, short term investors.

So people that might want the money in there for only a year, for example.

So a couple of key features about the fund, which we're the investment manager for.

So it's got target returns of over 10% per annum.

It aims to take advantage of short-term funding opportunities.

So it could be, for example, a bridging loan where a borrower has bought a property and is selling their property, but they don't quite match up.

So they might just need to borrow money for three months, for example, and are willing to pay a premium to do so.

We've also got a quick but thorough loan due diligence and loan approval process.

So it can be done, for example, in extreme circumstances, we have been able to lend money out within a couple of days.

But we're always very thorough with going through all the relevant details about the mortgage before approving any loan.

But

in the instance that someone's deal has fallen through with another party, we're often able to step in and save that deal.

And yet again, the borrower is willing to pay a bit of a premium to do so.

Over 75% of the mortgages held are first mortgages.

So that's a key feature that we look to try and keep that as it

means that if in the unfortunate circumstance a loan does go into default, then we will be first in line to get any money returned.

And the portfolio LVR is about 65%.

So this means that on average, we only lend up to 65% of the value of the property.

So it means that yet again, if it does go into default, it would need a 35% drop in the value of the property

before any losses are made.

So the fund is open to both retail and wholesale investors with a minimum investment amount of $10,000.

If you'd like any more information or you'd like the PDFs or application form, then you can email or call us and we'd be more than happy to help.

Thank you for your presentation, Chris.

Can you elaborate on how rising interest rates might affect both debt and equity investments in real estate?

Yeah, so with equity investments, the higher interest rates can increase the borrowing costs for developers and property owners, which potentially reduces the proper profitability of that project.

Additionally, it might mean that the value of the properties actually decrease as buyers face higher mortgage costs, which can reduce demand.

So this can have a negative effect on equity investors.

In terms of debt, it can have pros and cons.

If it's rising interest rates, then with every new loan that we make,

we're loaning out at the market rate.

So, you know, it means that with each new mortgage, they're often coming in with higher returns than older ones.

Why does a borrower choose a non-bank lender rather than a bank?

In short, it often comes down to speed, flexibility and the fact that we're able to tailor solutions to meet the requirements of the borrower.

We can be very flexible in terms of the terms, the rates, the repayment schedules and often we can do things like include the interest payable in the money that's actually loaned out to the borrower and we can then keep that

within the fund and use it to pay the investors each month.

There's also, as I previously mentioned, we're able to approve loans much quicker than regular banks are able to, as they've got regulatory requirements.

Whereas we can be swift and get deals over the line much quicker than the regular banks.

Thanks, Chris.

Thanks, Angelina.