Private Equity Vs. Private Debt: What Real Estate Investors Need To Know

Investors looking into alternatives to diversify portfolios, maximize returns, and manage risk have various choices within the real estate space. Within fractionalized and crowdfunded real estate offerings, investors may encounter private equity and private credit offerings. 

 While both involve the allocation of capital outside public markets, they differ significantly in structure, risk, returns, and their role in a real estate investment strategy. Understanding these differences is crucial for investors to make informed decisions that align with their goals and risk tolerance.

What Is The Difference Between Private Credit And Private Equity?

Private equity involves investing capital in private companies or acquiring stakes in them, typically with the goal of long-term appreciation. You’ve probably heard of large private equity firms that take companies private or invest in them before they are publicly traded and then share in the returns. 

In real estate, private equity funds often pool capital from investors to purchase and manage properties with the expectation of increasing their value over time. Investors receive returns in two main ways: through distributions from income from the property, such as rent, and appreciation of the property when transacted.

Private credit involves lending money to real estate developers or owners in exchange for interest payments. Unlike private equity, which aims to generate profits through value creation, private debt is structured around earning consistent income from interest. Private credit in real estate has grown in recent years because banks are less willing to lend. 

With private equity, you own the properties. Private credit, on the other hand, is about sharing in a loan. 

Advantages Of Private Equity

Private equity is often attractive to real estate investors because it allows them to share in the growth potential of a property or pool of properties. A significant capital investment, market repositioning, or extensive development can all add to a property’s value over time.

 For example, if you are investing in an older building that is being redeveloped, you will be contributing your capital with the expectation that the general partners in the property will use your funds to remodel the property, attract a well-paying tenant base, and increase its overall value. 

Disadvantages Of Private Equity

Private equity has higher risks than more conservative investment options. The assumptions made when the property was purchased may not come true. The market could shift, and the property type could fall out of favor. There could be a problem with the property, or the renovation could be poorly managed. 

Private equity is relatively illiquid. These investments often have a hold period that stretches over years. During that time, selling your share and getting your money back may not be easy. Real estate private equity deals are usually tied up until the assets are sold or recapitalized, which could take years. Because development takes time, receiving distributions from the property during your hold period may take a while. 

Advantages of Private Credit 

Unlike private equity, which focuses on ownership and value appreciation, private credit concerns income generation through interest payments on loans. That means that when you invest, you can expect to start receiving money like you would if you were a bank making a loan. 

The value of private credit is a predictable and steady cash flow. Depending on the loan terms, these payments may be fixed or floating. These loans have a set term, so you should know what to expect throughout the hold period. When the loan matures, you will receive your capital back and can put it into another loan or project.

Disadvantages of Private Credit 

Private credit investments are generally considered lower risk, which also means that the returns may be more modest. While private equity has the potential for the upside to be larger and smaller than anticipated, the upside for private credit is limited. The last few years have been good for private credit because interest rates have been high. As that shifts, rates for borrowing may lower, which could limit how much you can expect to earn. 

Remember, low risk doesn’t mean no risk, and there is the potential for the loan to default. Real estate assets usually back these loans. That means if something goes wrong, lenders will likely seize the property and try to sell it or operate to recoup the losses. An example was during the Great Financial Crisis when banks suddenly found themselves as the owners of many homes when people defaulted on their mortgages. If you are investing in private credit, it’s important to understand what type of loan you are participating in and what the terms are if the borrower defaults. 

How To Choose Between Private Equity and Private Credit

For real estate investors, choosing between private equity and private credit depends on their investment objectives, risk tolerance, and liquidity needs. If you are investing in private equity, you need to understand that the risk is higher, and there is a stronger potential that you could lose your original investment.

Investors may want to ask themselves before investing how this investment fits into their overall portfolio. If they have funds invested in the stock market, bonds, and other securities, this may be the money that they are more willing to risk to get higher returns. That would be a good reason to put some funds in private equity, especially if they don’t need the money soon. 

A private credit fund may be a better choice if the investor is more concerned about a dependable stream of passive income with low risk. Most investors diversify their holdings over a variety of securities.

Real estate investors don’t have to choose a single path and can incorporate private equity and private credit into their portfolios for a balanced approach. A hybrid strategy allows investors to pursue growth through equity investments while benefiting from the steady income of private credit. This diversification can help mitigate risk, balancing the high-growth, high-risk nature of private equity with the stability of private credit.