Risk 1: Illiquidity
Equity investments are inherently less liquid than stocks, meaning they cannot be easily converted into cash. While these investments might generate dividend payments, selling your shares to recover your initial capital can be challenging. As an equity investor, it’s crucial to ensure you don’t anticipate needing this capital in the short term.
Risk 2: Bank Involvement
When securing financing for a deal, lenders often review company formation documents to identify ownership and determine who will guarantee the loan. Typically, a guarantor must hold at least 25% ownership in the company. As a cash provider, you should be prepared to appear on the bank’s radar, where your credit profile may be scrutinized. Additionally, you may need to engage directly with the bank during the financing process.
In joint ventures, cash providers typically don’t receive collateral as part of the bank loan. However, they do receive shares in the company and can therefore operate behind the scenes since their name doesn’t appear on the title deed—the company does. This setup frees them to purchase other properties under their personal name, offering more flexibility for future investments.
Risk 3: Time Commitment
Equity investments often involve longer time horizons for returns. Your capital will typically remain tied up until the property is sold, which depends on market conditions. For example, fix-and-flip projects generally take about 9 months, while rental property investments may span several years. As an equity investor, you must be comfortable with this extended timeframe.
Risk 4: Market Volatility
Property investments offer the potential for high returns but are also subject to market fluctuations. For instance, if a fix-and-flip property sells for 10% more than expected, you could share in that gain. Similarly, if rental income increases, a portion of that upside is yours. However, you are also exposed to risks if the deal underperforms. In some cases, additional cash contributions may be required to keep the project on track. Equity investors must accept this variability, as returns are not fixed like those from loans. If such volatility feels uncomfortable, you might prefer the steadiness of private lending.
Risk 5: Tax Implications
Equity investments have immediate tax consequences. Profits from a fix-and-flip or rental income earned are typically taxable as soon as they are realized. It’s the cash provider’s responsibility to consult with a tax advisor to prepare for potential tax liabilities.
Other Risks
Each deal comes with its own unique set of risks, emphasizing the importance of thorough disclosure. Investors must have a clear understanding of the specific risks involved in each opportunity before committing capital.
Why Equity Investing is Worth It
Despite these risks, equity investments offer an unparalleled opportunity to build wealth and diversify your portfolio. The potential for high returns, coupled with ownership in tangible assets, provides a level of security that many other investments cannot match. You get the chance to actively participate in and profit from real estate projects that you believe in, while benefiting from the upside potential of property appreciation, rental income growth, or successful project execution.
Equity investors also enjoy the satisfaction of being part of impactful ventures, such as transforming properties, revitalizing communities, and creating valuable assets. Over time, the experience and financial growth gained from these investments can outweigh the initial challenges, making equity investing a rewarding path for those who embrace the journey.
