When Using Private money, Is It better to structure Our Deals as Debt or Equity Plays?
As storage investors, we talk a lot about how to get our deals funded. And while what follows is clearly an oversimplification, I want to share some insights that will help guide you. When faced with raising private money to fund a deal, new investors often wonder about the best way to structure their deal. I’m often asked outright, “Which is better, giving up an equity position or using debt to fund a deal?”. The short and entirely unhelpful answer is almost always, “It depends!” And perhaps more surprisingly, it doesn’t even matter all that much!
Let's say, for example, that you have the opportunity to invest in a self storage facility that can support a 12% interest debt investor. But unfortunately for you, the only investor you can find at the time insists on getting an equity position. Are you out of luck...or is there a potential work around? The good news is that there is a way for you to structure the same deal using an equity position (instead of debt) that will result in the exact same PROJECTED overall return for your investor. Without knowing the specifics of the deal, we can’t say if that would be a 8% equity stake or a 15% equity stake as that will, of course depend entirely on the financial performance of the property. The concept to understand here though is that for every imaginable debt structure, there exists a set of equity terms that would yield the same Return On Investment (ROI) for the investor.
Bear in mind, of course, that equity investors are taking on more risk (because at least some of their returns are variable rather than fixed) and will therefore often require a greater return than debt investors. Whether or not you can provide that higher rate of return simply depends on the deal at hand.
And though I don’t want to overcomplicate the matter, you should at least be aware of the fact that choosing between debt vs. equity does not have to be a “one or the other” decision. We often use hybrid models where an investor will get a fixed return (similar to a debt position) as well as a small equity stake in the property. In this way, they are getting the best of both worlds. That’s a discussion for another day and will likely be one that is better had via a full length Video Presentation within The Storage Rebellion University.
Before signing off, I thought it might be helpful to give you an idea of what I am seeing in the markets right now relative to private money interest rates. I can usually get debt investors interested (assuming adequate collateral/security) by offering an annual ROI of between 8% and 12%. At 8% to 9%, you are looking at the principal and interest payments starting right away. If the investor prefers a bit higher return but is willing to take interest only payment instead of principle and interest payments, I might be able to pay 10% to 11% and if they are willing to take all the payments at the end of the deal in the form of a balloon payment, I have been known to offer as much as 12% simple interest. As you can likely see, I am willing to pay MORE interest in exchange for repayment terms that allow me to experience better cash flow while we are getting our properties turned around. Very generically speaking, we target 15-20% returns for our equity investors.
Hopefully, that adds at least a bit of clarity to the question of debt investors versus equity investors. I plan on diving much deeper into this topic as well as other aspects relating to how to properly fund storage deals on some upcoming Live Training Calls hosted within The Storage Rebellion University. Click here to Trial if for FREE!