#23 What's Better - a Debt or Equity Deal?

Welcome to the Passive Income MD Podcast where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey everyone, I hope you've had a great week. Before we get started today, I have to tell you, I'm super excited. I've been waiting about eight or nine months for this and many of you have been waiting as well. But today we are launching our next enrollment for our next class of Passive Real Estate Academy. For those who have no idea what that is, for those who are thinking about investing in passive or private real estate deals like syndications or funds and you're just not sure how to actually learn how to do the proper due diligence for them. Well, we've built a course for you and the goal of this course is in four weeks to get you to a place where you can confidently invest in these real estate deals. Know what to invest in, know what not to invest in, have a community of support around you, get access to exclusive vetted deals as well as, again, an amazing community later on to vet deals with collectively. And I can't do better than put this whole group together as well as this course in terms of a resource. And I'm super excited to really be able to announce it. And for the next week, we're going to be having open enrollment where people can join and join our next class. After that, we're not sure when the next class will be. It all depends on our schedules and we do a lot of live Q and A. So it really depends on how the schedule goes. If you're interested at all, I highly recommend that you go over to passiveincomemd.com course and check it out. Thanks so much. Now let's get started. Now, I have a lot of people that come to me and they get presented with these passive or private real estate deals and whether they've seen it online through some crowdfunding platforms or whether they've been passed something along by a friend or maybe they went on a website or on an email list and they've gotten a deal and they come to me and they say, I don't even know where to start looking at this thing or start to understand what I'm looking at. I mean, they see some numbers, they see what the property might be and they say how do I actually start? And you know what I normally tell people is when they look at the deal. I tell them, look, is it a debt or equity deal? And that's usually the first question I ask them. And for most people, they look at me and they stare back at me and they say, I'm not sure what you're talking about. So for that reason I figured we, we should talk about that today. That's one of the most important things when you look at a deal to understand at the very basic level, is it a debt or equity deal? And I'll talk about each of these. So what is a debt deal? Now all of us are very familiar with debt, student loans, mortgages, I'm sure many of you have at least one, maybe both of those. And we're usually on the side where we are a borrower. And so we pay the bank or whoever that might be at a set interest rate. A lot of times it's bundled into in terms of your principal and your interest and you pay them back as time goes on at a set determined rate for a set term. Now when you are an investor, there are these things called debt deals where you essentially act as the bank, meaning that you lend out your capital that you earn elsewhere. You lend it out to people who are willing to pay you a fixed interest rate over a certain period of time and at the end of the term pay your capital back. Typically these things are interest only type of deals where they pay, you know, whatever it is, interest that they owe you per month and at the very end they return your capital in full. For example, there might be somebody who is trying to do a fix and flip of a home and they need to borrow money to do so. Usually conventional banks don't lend on these type of things. They're too risky. If anybody has actually tried to get a home loan, you know, the scrutiny involved today in trying to get that mortgage, well, for a fix and flip, forget about it. They're not going to get a loan by conventional methods. And so they have to find outside sources for those loans. Usually those loans that they're looking for are things called hard money loans. And that's another term for this type of lending. Well, you as an investor, you might say, hey, I can lend you $500,000 for your project and they're willing to pay you an interest rate of, let's say anywhere from 8 to 12% for doing so. Now I know what a lot of you might be thinking. That's a high interest rate, especially in today's environment, especially when you see the mortgages that are at the time of this recording, they're at pretty much all time lows and you're seeing numbers in the threes and if it's over 4, it's unheard of at this point. Well, when it comes to these hard money loans, because they are somewhat riskier loans and they're actually not being given out by conventional lenders, people can charge anywhere from 8 to 12% these higher interest rate loans. Now they're also not holding it for these long periods of time. Usually these things are anywhere from 6 to 12 to 18 months at most. Now it's a nice thing for the investors, the ones that are lending this money out, because it's totally passive. You're lending money out and someone is actually taking that money, making use of it, and they're paying you back interest. And we all know it must be a pretty good thing to be the bank as long as people are paying you back as promised. So when you look at a deal, you're just trying to figure out, is this a debt deal, a situation where the investors are lending out money at a predetermined interest rate and really have nothing in terms of the upside. I mean, that's all they expect to get their interest rate and their capital back. Well, these type of deals are pretty nice because they're simple to understand. Like you don't care what happens on the backside, you don't care what happens on the side of the borrower as long as they're able to pay you back. It's a set amount and you can predict what you're going to get. Now there are individual debt deals where you just loan out for one single property. Now there are things called debt funds as well. You actually get together with others, pull your capital and then ultimately they lend out to multiple people at the same time and help you get a return on the backside. I already mentioned one of the cons, which is that you don't have any access to the upside, meaning that it's just a flat rate for you. So if, let's say the borrower goes out there and crushes this deal and makes five times their money for whatever reason, you don't have any access to that upside. But that's okay because you know that going in, you just want your interest rate. Now one of the other big downsides to investing in debt is that it is taxed as ordinary income. You're not getting long term capital gains tax. There's no favorable tax benefits to these debt opportunities. One of the major reasons that people invest in real estate is because of the Tax benefits. So for some people, investing in debt is off the table. However, for some other savvy investors, what they do is they invest in debt opportunities using the retirement funds. That way they can continue to get the gains tax free and they just continue to roll these deals into the next one and are able to do so at a tax deferred basis. Hope you got that. Well, the next thing I want to talk about are equity deals. So let's say debt deals is where you act, you know, or where you act as the bank in equity deals. You, you are essentially a partner in the deal. You might be a smaller partner, a limited partner, and you're not what's called the general partner, which is the, you know, which are the people that are actually running the deal. But you're investing in buying essentially a share in the property or the properties if it's a fund. So these deals are nice because you are actually riding with the people in the deal and you have access to all the upside. Now you have access to the downside as well, especially if the deal doesn't do well. But if you happen to invest in a great opportunity that, you know, doubles your money, triples your money, you get to participate in all of that. Now these deals, I tend to find are longer than the debt deals. If I mentioned the Debt deals are 6, 12, 18 months. I mean, that's because they don't want to hold whoever the borrower is, they don't want to hold these high interest rate loans for that long. When it comes to these equity deals, you're usually riding on these deals anywhere from three to seven to 10 years. Now for some people, they want to be in these deals three to seven to 10 years because they want that consistent cash flow that comes from being a part of these deals. And they don't want to constantly churn these deals like a lot of times you have to do in these debt deals. As a result of it being these longer type deals and that you're participating in the opportunity as a partner, you have access to a lot more tax benefits. There's something called depreciation when you buy a rental property. I've talked about it before. When you buy a rental property, the government basically states that the building itself and all of the things inside of it have a shelf life. You know, over time they're going to depreciate or devalue and you're able to deduct that, I guess yearly or whatever it might be on your taxes. You can use those deductions to offset Income from that deal. And if you, you know, deductions are large enough, you can use that to offset income from other deals. Again, a lot of people invest in real estate for the tax benefits alone. Well, I wouldn't say the tax benefits alone, but that's one of the major priorities when you're investing in real estate, to create some of those tax shelters and take advantage of that. Especially us as physicians, you know, we just don't have opportunities to really minimize our taxes in that type of way. You know, investing in real estate allows us to do that in many cases. And so investing in these equity deals really helps us tap into a lot of the tax benefits of investing in real estate, including the depreciation that I mentioned. Now, for some people, the downside is actually the length of the deal. As I mentioned before, some people like to be in those deals, those longer deals, so they don't have to constantly look for deals. But for some people, they know that their money's gonna be tied up for that long, three, seven, ten years, and they don't like that. They'd rather do some of these debt deals where they know that their money is gonna be held only for 6 months, 12 months, 18 months, and that sort of thing. Now, when you invest in an equity deal, it might be as a partner in a single property, and that's usually what's referred to as a syndication. You know, it usually means you're investing with a pool of people, pool of capital to invest in one property itself. Otherwise it might be a real estate fund. Essentially you pool funds, but you invest in multiple types of properties or multiple properties at the same time. They might buy apartment buildings all across the country or in different areas of their expertise, but it's usually a basket of properties all held under one fund. Now, you as the fund investor, you actually own a piece of each of those companies according to how much you invested in. The fundamental. The question I also get a lot in this scenario is, should I be investing in these equity opportunities in retirement accounts? And as I mentioned, a lot of people like to do that with these debt opportunities. Debt deals, debt funds, because they don't have to pay those capital gains taxes and can defer those and continue to kind of turn those deals over and get tax deferred gains. Well, when it comes to these equity deals like syndications or funds, the problem with putting them inside retirement accounts, it's not necessarily a bad thing, but you lose a lot of the tax benefits, unfortunately, for having them within those deals. So what do I do? I tell people I invest in both debt and equity. I'm looking for ultimate diversification. I like to invest in debt. I like to invest in debt funds. I like to invest in smaller equity deals and single properties. I like to invest in equity deals. These funds as well. I do them both in and outside of retirement accounts. I try to be smart about it. Again, most of the times I try to put the debt inside retirement accounts and leave the equity deals out. But sometimes I do invest in debt outside of retirement accounts. All of this I'm mixing matching to ultimately try to get the cash flow that I desire on a monthly basis to really allow me to live the life that I want to live. So I hope that makes sense. I tell people Again, when you first start looking at a deal, try to understand, is this a debt or equity deal? When you look at a crowdfunding platform, a lot of times they'll just have it right there in front of your face. But when you presented an opportunity, I tell people to look out for that and then understand the upsides, the downsides, and then start actually getting into the deal itself, including who's running the deal, to understand is this something that is going to help you accomplish your goals? Anyways, hope that was clear. Have a fantastic week everyone. Take care. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group Passive Income Docs, and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.