When looking to invest, you can choose to invest in a company’s performance or their debt. The simplest difference between the two is an investor’s appetite for risk, returns, and liquidity. Both approaches have their place in investment strategies, and some investors choose to diversify in both. Below, we’ll introduce some advantages of each and why both sides of this investment coin can make sense for many investors.
Equity investments are what many people might typically picture when they think of investing. Stocks are a good example. You are investing in a share of the future performance and worth of that investment. It’s a bet and a gamble. In real estate, this may mean periodic distributions (passive income) generated from rents as well as larger potential gains upon sale of the property. Either way, you’re risking that the investment will perform well and sell for more than your initial investment.
Debt investors act as lenders, contributing capital based on predefined terms and a fixed rate of return. Bonds are an excellent example. You have no ownership or share. In real estate, the performance or sale of the property would not affect debt investors’ returns beyond the borrower’s ability to repay their debt. If the asset performs poorly, the owner, sponsor, or other equity investors absorb the losses first. If the borrower defaults, the loan is secured by the property. Either way, debt investments have some level of protection in comparison to equity investors. As a result, this approach is generally considered safer and will yield smaller potential returns.
Both equity and debt investments are part of the capital stack; the typical components representing most investments. The basic chart below is for example purposes only, but it illustrates how an investor’s place in the stack affects the general risk, returns, and liquidity of their investment.