Why are Canadian Real Estate companies raising capital via equity rather than debt?
The process to develop a real estate project is very straightforward, basically, the developer will need to have in the pocket at least 20% of the total amount to kick-off and once they take it from the ground they start to offering to the general public. Earlier buyers will pay less and once the property is finish developers will ask the full price. Usually, that 20% comes from bank loans through a very demanding and red tape process. However, in the past years, we are seeing a new way to approach the first funds, by raising capital via equity. While both approaches enable developers to access third-party funds, differences between risk strategy, business model, and new technologies available, determine that equity is more beneficial for developers.
When comes to real estate, three primary approaches allow investors to make money: increase property value, rental income, profits generated from business activities. All three are conditioning to some situation in the future, that may or may not happen. Nevertheless, once the bank loan application is accepted, there is no conditioning attached to the payment, other than the due date. If you make it through, great, if you don’t you need to pay anyway. On the other hand, the equity approach is quite different, as developers are not borrowing anything, they are offering shares to an investor, which means they have a partner, not a creditor. For sure, there will be the implication, if the project goes down, but the consequences will be less severe.
Additionally, the business model can be more effective and dynamic. Whereas, the debt has all the rules established previously, the fact that equity is usually conditioned to a future event can provide a better ROI than expected. Let’s say if the real estate market in that specific region skyrocket, as consequence, the price will increase and investors will access better ROI. You can say this can be considered a downside for developers, as they could get alone the benefits of the price increased, but it is important to keep in mind that the investor faced the risk along with them, so they deserve it.
Another reason that made equity in real estate is becoming ubiquitous is own to new technologies available. Most preciously the digital securities. Digital securities are a fully digitized representation of financial securities and they can break down into small pieces that represent any value. Also, it is possible to add rights to it, such as vote. In a nutshell, now is possible to invest in equity through a couple of clicks, in a safe a compliant way. High-class commercial real estate property can be available for the general public, not only for those who have the deep pocket to invest.
Real estate companies will always be looking for third parties funds, as a way to mitigate risk and expand their portfolio. This means debt and equity can always be resources. But, in a world that things change so fast, building a partnership is a good way to overcome unforeseen challenges and add value to the organization. Remember, “People don’t sink the boats they’re riding in.” In this scenario, equity is a better fit compared to debt.