Types of Equity

In another article in our library, we discussed debt financing.  In this article we will discuss equity financing and how it affects you as an investor.

When making an investment, you want to know how you are going to acquire assets from 0 percent to 100 percent financing if you are not paying all cash.  Most multifamily and apartment community investments utilize debt financing and equity financing.  The other percentage that would be used to acquire an asset that is not debt, would be equity or cash.  Given that you are purchasing businesses, you are in most cases raising money to buy these businesses. This is why we reference equity because an investor is buying a stock. In our article regarding debt, debt was described as a bond.

Given that you are purchasing businesses, you are in most cases raising money to buy these businesses. This is why we reference equity because an investor is buying a stock. In our article regarding debt, debt was described as a bond.

In this case, since the investor is buying the equity, the investor would be buying a stock or an ownership interest. The investors ownership interest, given that it’s equity, is based on the performance of the asset, where a bond would be based on a fixed interest rate. If something happens to the property investment and it doesn't go well, the investors ownership is backed by the bond or the debt instrument. Equity investors prefer higher risk that result in a higher reward or yield.

Rather than having a low yield fixed rate debt obligation, they want a percentage return, but also want to have a larger percentage return on their investment as a multiple growth.  The investor is investing in the potential upside in the deal and therefore taking the risk that the deal may or may not go as planned.

Let’s breakdown the most common types of equity.  Though there are others, this article will reference the most common as it relates to commercial real estate and multifamily apartment community investing.

First, there is private equity or private partnerships investors can pursue via private placements.  In multifamily apartment investing, these are normally referred to as syndications. In a syndication, a general partner forms a private investment vehicle via a private placement.  The general partner would then market to investors to raise capital for the single property investment project.

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Section 506 of the SEC’s Jobs act regulates these investments.  In a 506b, general partners may NOT publicly solicit for investors and may have up to 35 non accredited investors.¹  In a 506c, general partners MAY publicly solicit for investors and may only include accredited investors in the investment.²  An accredited investor is someone who’s net worth is $1 million, excluding their primary residence either individually or with a spouse or partner and or someone who’s income exceeds $200,000 individually or $300,000 with a spouse or partner for the previous two years. ³

An accredited investor is someone who’s net worth is $1 million, excluding their primary residence either individually or with a spouse or partner and or someone who’s income exceeds $200,000 individually or $300,000 with a spouse or partner for the previous two years.

Next, there is public equity, which would be publicly traded stocks, and as it relates to real estate you have REITs (Real Estate Investment Trusts). As an investor you can invest in a REIT which purchases commercial real estate

There is also Joint Venture equity. For JV equity, you would find a private equity firm, which could be a family office, or some type of investment company that has discretionary capital that wants to invest in multifamily apartment communities. You would form a joint venture with them. They would in turn write you a single check and you would purchase the property.

There is another type of equity called pref equity, which sits in between the debt and the cash that you would be bringing to the table as the general partner. Pref equity interest rates are higher than common equity, and in most cases, the pref equity does not participate in the upside of the project.

There is another type of equity called pref equity, which sits in between the debt and the cash that you would be bringing to the table as the general partner. Pref equity interest rates are higher than common equity, and in most cases, the pref equity does not participate in the upside of the project.

Another type of equity investment could be a fund. The fund would be outlining the type of assets they want to invest in, whether its value-add, core or opportunistic. The fund would then reach out to its investor pool with a goal to raise $20 million, as an example. Once the investor from the pool signs the private placement memorandum they are committed, and the fund will start seeking deals. General partners and firms like the fund model so that they know they have the capital on hand rather than having to raise money on every single deal on a single basis, ie. syndication.

Now let's discuss the yield associated with these types of equity structures.

The yields associated that most investors would expect, are called a preferred return. There would be some type of profit split. Profit splits are based on a few different measurements.  Examples of those measurements are Internal Rate of Return (IRR) and Equity Multiple. An IRR hurdle is a time value of money calculation and is the discount rate of future cashflows. An Equity Multiple is the percentage multiple on your invested dollar. If you invest one dollar, and then you receive two back, that's a 2x Multiple on your initial investment.

An Equity Multiple is the percentage multiple on your invested dollar. If you invest one dollar, and then you receive two back, that's a 2x Multiple on your initial investment.

A preferred return is a year over year dividend that you expect on your investment.  It’s the incentive the general partner is willing to provide to attract investors to invest in a project. As an example, a preferred return can be 8 percent. You’ll receive an 8 percent preferred return on your capital and also a profit split (promote). The general partner gets promoted to their profit split if they follow the business plan. If they follow the business plan correctly, the split would be 70 percent to the investor and 30 percent to the general partner. So as an investor, you would get an 8 percent preferred return year over year on your investment, and 70 percent of the upside, or profit, in the investment when the property investment business plan is completed and sold.

Most of these equity investments, JV equity, preferred equity, a fund, a syndication single, private capital raise all have these general yield parameters associated. We will dive further into the formulas and calculations, as well as the percentage return expectations in other articles within our library.  

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^{1 - “Private Placements - Rule 506(b),” SEC Emblem, May 4, 2017, https://www.sec.gov/education/smallbusiness/exemptofferings/rule506b}

^{2 - “General Solicitation - Rule 506(c),” SEC Emblem, May 4, 2017, https://www.sec.gov/education/smallbusiness/exemptofferings/rule506c#:~:text=Rule%20506(c)%20permits%20issuers,in%20Regulation%20D%20are%20satisfied}

^{3 - “Accredited Investor,” SEC Emblem, March 26, 2022, https://www.sec.gov/education/capitalraising/building-blocks/accredited-investor}