debt side vs equity side

Just got off the phone with a real estate analyst in the debt group @ Blackstone for an info interview.

He works for the debt team and told me that most kids want to get into the equity side as opposed to the debt side, and that I shouldn't "come in here looking to break into the equity side".

Why do people prefer equity side? What would be a strong argument for the debt side?

Interviewing for debt side on 4 days, and I know I will be asked this question.

Thanks!

Comments (41)

Sep 26, 2012 - 3:20pm

Six years later... Hilton still comes up. Huge deal.

I'll do what I can to help ya'll. But, the game's out there, and it's play or get played.
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Best Response
Sep 26, 2012 - 3:29pm

By people it seems as if this guy is referring to kids. Debt investing is about downside protection, tight covenants, legal docs which give you various rights and remedies. You care about principal protection. Upside is limited since at the most basic level you are getting only your original investment, plus interest back.

No in reality things get interesting when you lend deeper into the capital structure, you have PIK, equity co-invests, penny warrants, prepayment penalties, amendment fees, etc.

Equity investors have ownership. They can realize much more upside, control the business, etc. Much more hands on. As a debt investor you are just along for the ride as long as covenants aren't tripped.

And least, but not least, it is less well know than equity. Most freshman finance students know what PE means. But I doubt many of them can explain debt investing or how mezz works.

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Sep 26, 2012 - 5:24pm

Everything that TNA says is true, but I would also note that Blackstone's real estate debt group (BREDS) is focused on the very type of more-complex, mezz-style investments that TNA describes. I agree that this type of debt investing is much more interesting and potentially lucrative than your typical bank/lifeco senior mortgage, but I can also appreciate why a knowledgeable real estate professional (myself included) would be biased to working in opportunistic equity investing rather than high-yield debt investing.

As TNA mentions, equity has all the ownership, control, and upside, which in some ways are the very elements that make the investing business interesting and appealing. I also think that as an equity investor, to some extent, you get exposed to and understand the complexities of structured finance (albeit from the other side of the negotiating table), much more so than the typical mezz lender is exposed to and understands the business of owning and operating real estate.

Sep 26, 2012 - 7:29pm

tl;dr... Debt is hot.

Now for the long version...

Since the financial crisis, distressed debt/special situations strategies have been a lot more lucrative than the non-existent LBO type real estate investing that grabbed the headlines 5 years ago (Hilton, EOP, etc...). From an old post of mine about Blackstone's RE debt investing:

"As I understand it the RE debt fund is managed by the same RE team that manages their opportunity fund, pretty much. I like that they have the flexibility to do various things with the capital (existing and new mezz, preferred equity, performing an non-performing loans, etc...) and take a value investing approach"

If this is still the case it will be an extremely interesting area to work in. The most reputable real estate investors of former eras made a lot of their money (and reputations) in distressed or debt style investing in the 80s/early 90s. Also, a lot of debt investing during the 2 years post-Lehman's bankruptcy were very much control type situations in highly leveraged capital structures. The difference is that instead of layering on LBO debt like pre-2007 deals, the entry point would be buying the mezzanine or the fulcrum debt to gain control of the deal or a strong bidding position in a foreclosure/bankruptcy. This can be the sexiest type of investing in private real estate. Like Non-Performing-Loan investing in Japan or RTC in the US in the old days.

Depending on how the fund is set up and the strategies they're open to using the real estate targets can be anything from a pool of loans, to half completed real estate projects to portfolios of some of the best real estate assets or hospitality companies in the country (check out Brookfield's deal on Kerzner international). They could by buying the debt and restructuring/owning some of the over-leveraged LBOs that made the headlines years ago.

Having said that, these strategies are a lot more difficult now that asset values have shot up over the past couple of years and all of the easy credit/monetary policy.

Sep 26, 2012 - 7:35pm

All,

thanks for clearing that up. high-yield debt lending (mezzanine debt) sounds highly complex and interesting. I just want to be on the lending side and calculate debt yield and LTV ratios all day long. I like the stability of debt; it captures my personality better than the capricious nature of equities.

Haters gonna hate

Sep 26, 2012 - 7:53pm
advantageplayer:
All,

thanks for clearing that up. high-yield debt lending (mezzanine debt) sounds highly complex and interesting. I just want to be on the lending side and calculate debt yield and LTV ratios all day long. I like the stability of debt; it captures my personality better than the capricious nature of equities.

You want to sit at a desk and calculate debt yields and LTV ratios all day? Good god. I hope that was a typo.

Jan 13, 2022 - 3:30pm

Voice that in your interviews for sure (maybe more eloquently - leave out the part about calculating debt yield/LTV and focus on why you're more suited to debt investing). It's true that a lot of kids are just trying to get any job in the industry and eventually want to go to the equity side, so it can help set you apart if you come across as genuine.

Agreed with others that this type of debt investing can be very interesting and complex. I wouldn't want to go do lending at a bank shelling out first mortgages at 300bps but could easily get excited about private debt.

Sep 28, 2012 - 3:58pm
re-ib-ny:
One thing to add...most opportunistic equity players buy or originate mezz debt investments regularly, often (but not always) with an eye to gaining control. These are some of the most interesting investments.

So true, this is the new hotness in RE investing. I think this trend will accelerate into the future. There has also been a push in my group to explore distressed debt and loan-to-own, but management has been reluctant because we need to staff up for that.

Experience in RE debt will continue to become more valuable as investors look torwards acquiring and working out existing debt as a new strategy.

Tom Barrack (circa 2011) - "Debt is the new equity."

Man made money, money never made the man
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Sep 28, 2012 - 6:45pm

I think the best investors in real estate private equity investing are those who have the ability to invest up and down the capital structure (debt and equity). This matters a lot when you move from one leverage or business cycle to another.

It doesn't make sense to hamper oneself by focusing only on one part of the capital structure when a lot of transactions are motivated by refinancing, de-leveraging, foreclosure and bankruptcy, or potentially pre-IPO REIT financing, i.e. processes that depend on transforming an asset/company's capital structure.

Sep 28, 2012 - 6:50pm
Relinquis:
I think the best investors in real estate private equity investing are those who have the ability to invest up and down the capital structure (debt and equity).

Agreed.

Man made money, money never made the man
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Sep 29, 2012 - 2:19pm
Relinquis:
I think the best investors in real estate private equity investing are those who have the ability to invest up and down the capital structure (debt and equity). This matters a lot when you move from one leverage or business cycle to another.

It doesn't make sense to hamper oneself by focusing only on one part of the capital structure when a lot of transactions are motivated by refinancing, de-leveraging, foreclosure and bankruptcy, or potentially pre-IPO REIT financing, i.e. processes that depend on transforming an asset/company's capital structure.

Agreed. OP: When you're the CEO / investment committee level guy one day, you need to understand every deal that comes your way - not just straight equity deals. Also, if you worked in debt strategies at Blackstone you can be very confident that no one will hold that against you. I'm at mega-type firm now working primarily on equity deals and I came from specializing in mezz/preferred - and at a much lowlier place than BX.

interview is no joke though...

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Sep 30, 2012 - 8:28pm

Who makes more debt or equity guys? (Originally Posted: 03/17/2015)

I'm a junior at a target (Ivy) that is interested in investment management and am deciding whether to pursue equity or fixed income investing roles. I currently manage my own stock account and I enjoy researching equities as well as selling the upside. However, last summer I worked at a debt fund and also like the complexity of fixed income securities.

All else equal, I am just wondering who makes more money in general? I have heard fixed income guys say equity guys make more money and I have heard equity guys say fixed income makes more money.

I would be kidding myself and lying to everyone if I said money does not play a factor in my professional decision making so please don't dishonor my honest question.

Thanks!

Sep 30, 2012 - 8:29pm

You probably know this is a dumb question but in general equity investors makes more when they win, and lose it all if they lose.

Equity has to make more in general, if you understand how the asset class works. Just check out Ackman's latest powerpoint. Debt is guaranteed by the underlying business, equity can be wiped out anytime. Risk return trade-off.

It's why private and public debt funds will sometimes do equity (form of convertible debt) in order to juice up returns.

Sep 30, 2012 - 8:30pm

SanityCheck:

You probably know this is a dumb question but in general equity investors makes more when they win, and lose it all if they lose.

Equity has to make more in general, if you understand how the asset class works. Just check out Ackman's latest powerpoint. Debt is guaranteed by the underlying business, equity can be wiped out anytime. Risk return trade-off.

It's why private and public debt funds will sometimes do equity (form of convertible debt) in order to juice up returns.

Generally agree with SanityCheck. However, it is one thing to note that credit takes a variety of forms and these come with drastically different risk return profiles. For example, special sits, distressed, convertibles (as mentioned), etc. can offer equity like returns so its hard to generalize all forms of credit. I would go with your interests (as you will be more likely to perform better) and if you manage to get into a top credit or equity fund, I promise you that you will get paid either way.

Sep 30, 2012 - 8:32pm

Debt Banker VS Equity Bankers (Originally Posted: 08/18/2009)

For all the more experienced juniors out there, if you were forced to do banking all over again....taking lifestyle, career, and compensation in to consideration....would you work for a Debt Banker or an Equity Banker? Please elaborate.

Jul 4, 2018 - 9:10am

Wanted to bring this back for a 2018 perspective. Anyone on here working at a debt fund or platform, or anyone go from a direct equity position into a role structuring debt/lending into the cap stack?

For the most part you see posts of people trying to end up in equity positions, however there are now thousands of equity shops chasing the same deals. Coupled with movements in interest rates and their impact on deals penciling, I'm curious to see if people have moved to the debt side of the table, either through changing jobs or their fund changing strategy. Any color on the state of the market, deal flow, pros and cons, etc?

Jul 9, 2018 - 3:27pm

Work in RE debt and don't work at a debt fund but I've talked to some people in the field. There is also hightened competition within debt funds. 2017 was a record year for real estate debt fund capital raising. Spreads have started coming in but from what I've heard they are still plowing ahead and doing deals.

Commercial Mortgage Alert released a list of all the mezz lenders (mostly debt funds), their target gross IRR, property type they focus on etc. I saw some that target 12-15% gross IRR which I imagine is higher than many core equity funds. These higher IRR funds do a lot of construction / heavy renovation / risky repositioning deals, and as a result they will think more like equity investors than a credit investor solving for DSCR.

I'd work at one of these debt funds targeting high IRRs over a sleepy core fund any day, but it's always going to depend on the situation and your long term goals. At the end of the day you can make a ton of money doing either. Just do what sounds interesting to you.

The best argument for debt is the high number of deals you'll see. There's a good mix of underwriting, structuring, syndicating at the debt funds. Lenders can often move to the equity side but be in charge of arranging financing.

I'm on my phone so apologies for rambling thoughts

Array

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Jul 9, 2018 - 11:17pm

It does seem like everyone has a debt fund right now, with even the big life companies trying to get in on the action. Because of the relative slowdown in sales, coupled with the enormous amount of available cash, debt deals have been harder and harder to win lately. Spreads have tightened as the treasury has gone up, which is hurting relative value (mortgages typically look for a 50+ bp spread on like rated corporate bonds) and making mortgages less attractive (at least on the balance sheet side).

Debt funds are a little different. With leverage, debt funds are able to take those 5 coupons and juice them to 7s and 8s. When you are secured by 30% equity and getting a 7 or an 8 right now, it doesn't necessarily make sense to be in the equity position.

Aug 2, 2018 - 12:02am

Most debt funds take out loan-on-loan facilities to leverage their returns.

Say a Debt Fund does a L+350 loan at 65% LTV. They will put the loan on a line of credit with Lender that will lend them 65% on the 65% for say L+250 (essentially this is using Debt Fund's credit). Debt Fund is in for 22.75% of the loan (35% equity, 65% on the 65% is 42.25% that was returned by Lender, and the Debt Fund still in for the remaining 22.75%). But now, the Debt Fund is scraping L+100 on the 42.25% that was returned (the spread between what the borrower is paying and what Debt Fund is paying to Lender) and then getting L+350 on the 22.75% that they still have in the deal. That is basically L+535 based on the 22.75% they have in the deal.

You can basically take a core loan and juice it to a value-add/mezzanine return.

Loan on Loan lines are very niche products, but most of the large banks offer this kind of credit line, with WF being the biggest in the industry.

Aug 10, 2018 - 11:42pm

bump for other opinions on whether to join an equity vs debt deal team in today's environment

Array

Aug 11, 2018 - 7:28am

A debt shop will most likely allow you to work across more asset classes, which can be a tremendous advantage. If you look at 2-3 deals on the equity side, that could be 10-15 deals on the debt side. Faster pace and less chance of being Silowed into one or two asset classes on the debt side than the equity side as a result. I think the broader exposure and faster pace is great at a junior level. And tbh, there's a ton of overlap in how you think from a mezz perspective and from an equity perspective. It's very common to see people move from one side to the other at top shops, ex. Equity at Oaktree to Debt at BX/Brookfield. I don't think you can go wrong between good mez lenders and equity investors. Structured credit is probably the most complex/interesting area in the RE cap stack and takes a different type of mindset to be a good investor. That's more the hedge fund world vs. the RE private equity/private credit world.

Aug 11, 2018 - 3:09pm

Thanks for the thoughtful response. Is the higher frequency of debt deals vs equity deals just a sign of this market or is it more or less a constant? Also, would you say a potential reason is that it's "easier" to underwrite a debt deal (lower return hurdle, you don't care about maximizing upside of the collateral as long as you're paid back, etc) hence why debt guys are able to see more reps? Thanks

Array

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