Debt and equity financing are two common ways commercial real estate investors fund projects. Many projects will even use a mix of equity and debt for financing. When developing a plan, investors must weigh the difference between equity vs debt financing.

Equity vs. Debt Financing: What You Need to Know

Debt financing involves borrowing capital to fund a CRE investment. A mortgage usually is used to purchase commercial real estate. Bridge loans and construction loans are also common in commercial real estate. No matter the type of debt, the investor must pay it back over time with interest.

With equity financing, you take money from other investors in exchange for a stake in the venture. The funds could come from individual investors or venture capital firms. In this arrangement, you have no obligation to pay the funds back. Instead, the investors own a stake and receive some of the profits to see a return.

Now that you understand the difference between debt and equity financing let’s look at how they can affect investments.

Financing Costs

There’s no such thing as free money in commercial real estate investing. It all has a price. With debt financing, the price is paying the funds back with interest. There may also be various fees associated with obtaining the loan. Equity financing might not require repayment, but it does have costs. With equity financing, the price comes in sharing profits with other investors.

Ownership

When you finance with debt, you will have to pay the funds back. However, debt allows you to maintain ownership of the venture. The more you use equity to finance a project, the more you lose ownership. That means more profit-sharing, which could be more than you would have paid back on a loan. Beyond sharing profits, giving over ownership shares can also mean losing some degree of control. Your equity investors become fellow owners who might want a say in operations.

Risk

The financial risk tends to be greater with debt financing. When you finance with debt, you have full ownership, which means you accept all the risk. With equity financing, you can spread the risk between yourself and other investors. However, that’s where the balance between risk and reward meets. You take more risk with debt, but you can keep all the profits. Equity financing means less risk, but you must share the returns with other investors.

Cummings Commercial Real Estate

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