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Equity Financing vs Debt Investment: An Overview
- As you tread the waters of financial planning and investment, understanding how to make the choice between equity and debt investments can make the difference in how well your investment portfolio is going to perform.
- It goes without saying that understanding the nuances, risks, and potential returns related with equity and debt funds is crucial for crafting a balanced investment strategy.
Equity Investment: Ownership Based
Equity investment is often used synonymously with taking part in the stock market. Every time you buy ownership shares in a company, you buy an equity stake in it. Investors become shareholders, and go for the ride in sharing the fortunes and pitfalls of the business.
Pros & Cons of Equity Investment
Equity investment has the potential and allure of high returns, especially long term. Historically, stocks along with real estate have been the asset classes that outperform other options when talking about substantial capital appreciation.
However, stock market volatility is, and always will be a major concern of investors. Stocks can go through significant fluctuations and the value of your equity investments might plummet in just a day or two. For those who want assured long term returns and stability, and don’t want to keep an eye on the stock market index all day long, the unpredictability of the stock market might definitely be a turn off.
Debt Investment: Fixed Income
Debt investments or debt funds are those which primarily invest in fixed income securities. These may be bonds, lending money to an entity such as a corporation, government, or other organisations, treasury bills, and so on. The aim of debt investment funds is to provide investors with regular interest payments and preservation of capital.
Pros & Cons of Debt Investment Funds
If security and stability is what you’re looking for, then look no further. Debt funds and investments are infamous for their stability and regular income streams. Serving as a safe haven for risk-averse investors, these provide a fixed rate of return over a specified period. Bonds and fixed income securities in particular, offer a more predictable cash flow.
But with all things too good to be true, the trade-off of comes in the form of potentially much lower returns as compared to stocks and equity investments. Especially during times of inflation, the fixed returns might not be able to keep up with rising costs of living, and end up negatively impacting the value of investment.
Equity vs Debt Investment in Real Estate
| Criteria | Equity Funds | Debt Funds |
| Investment Objective | Seek long-term capital appreciation. | Aim for capital preservation and income generation. |
| Portfolio Constituents | Mainly invest in equity and related instruments (at least 65% of the portfolio). | Mainly invest in short-term and long-term debt securities like bonds, treasury bills, etc. (portfolio allocation into equities is less than 65%). |
| Risk and Returns | Higher risk due to market volatility; potentially higher returns in the long run. | Low to moderate risk; returns are usually low to moderate compared to equity funds. |
| Taxation | LTCG taxed at 10% (with exemptions); STCG taxed at 15% (subject to STT). | LTCG taxed at 20% with indexation benefit; STCG added to taxable income, taxed as per tax slab. |
| Ideal for | Investors with a longer investment horizon and a higher risk appetite. | Investors with a shorter investment horizon seeking potentially higher returns than bank FDs and savings accounts. |
Debt Investment in Real Estate Explained
- When investing in debt in real estate, you essentially invest in a property developer or investor’s loans. You become the debtor, and lend your money to individual real estate developers. Your investment money gets pooled in with others investing in realty debt and everyone receives a fixed rate based on the interest rate set with the borrower.
- Just like debt funds, investing in real estate debt is great for fixed income. Fixed monthly payments are received on two criteria: the interest payments received from borrowers, and the amount of investment.
- The real estate developers uses the investment to buy some property, whether commercial real estate or residential. This then becomes the collateral for the loan. In case of default, debt investors get paid before equity investors, and thus this is a better investment if you have a lower risk tolerance.
- Just like debt fund investments and debt mutual funds, the returns are lower than equity investments, but more secure and guaranteed.
Equity Investments in Real Estate
- Similar to equity investments in the stock market, equity financing in real estate means that you buy an ownership stake in a property, whether commercial or residential, and become a property shareholder.
- You get a part of the property’s profits, such as rental income, capital appreciation, and proceeds from when the owner sells off the property and pays the equity investors.
- Usually, equity investors help commercial real estate developers and investors by adding to their capital and funds for developmental projects. Equity investors become property shareholders and have rights to a certain allocated amount of the overall profit churned through the development of the property.
- As with equity investments and debt funds, equity investments in real estate have a higher rate of return than debt investments. Equity investments also have tax benefits like depreciation, no cap on potential returns, and lower initial fees.
- However, the risk is also high, and as always, future profits as well as capital appreciation cannot be guaranteed.
- Equity investment projects are also for a longer term than debt fund projects. And in case the real estate project fails, equity investors are usually paid last, if there is something to be paid, so equity investments are not for the faint of heart.
Bottom Line: Which Investment Is Right For You?
In the first quarter of 2023, debt mutual fund schemes witnessed inflows of a staggering 1.5 lakh crore rupees, as per the Economic Times. This easily outperformed equity mutual fund investments which had just about Rs 7200 crore inflow of investment across all categories.
This indicates that debt investments are slowly being more and more preferred over equity investments.
Finding the right balance between equity and debt in commercial real estate investments is a planned strategic endeavour. Factors such as the investors risk tolerance, investment goals, desire for stable monthly income or long term potential goals, all play a huge role.
The key is to balance risk through both equity and debt allocation and thoughtfully creating space for both investment types in your investment portfolio. Striking the right balance helps investors remain confident even in the face of market fluctuations.
Assetmonk, a new age alternative investment platform specialising in commercial real estate and fractional ownership of high end commercial properties, is always ready to guide investors on their journey towards building a well-rounded and prosperous portfolio.
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