A Simple Guide to Different Types of Debt Investments
Review a simple rundown of the most common types of debt investments: who they're best for, how they work, and why they're uniquely attractive.
What is a Debt Investment?
A debt investment is when you lend money to an individual, company, or government, and in return, you earn interest or a return percentage. Essentially, as the lender (or investor), you are providing capital in exchange for fixed or variable payments over a set period of time. At the end of the loan term, the borrower repays the principal amount. The most common types of debt investments include bonds, real estate loans, and private debt instruments.
These are the most common classifications types of debt investments:
Debt Fund: A debt fund is an investment pool where investors contribute money to a fund that lends to multiple borrowers. In return, the investors earn returns from the interest paid on these loans. Debt funds are often professionally managed, and returns are generated from a diversified portfolio of loans.
Debt Security: A debt security is similar to a fund, except they usually have a defined maturity date and coupon rate. Most debt securities, like a corporate or government bond, guarantee repayment of your principal. The downside is a lower return compared to investing in a fund.
Private Debt: Private debt refers to loans issued by non-bank institutions, typically to businesses or real estate developers, where the terms are negotiated privately. It is not traded publicly, making it an illiquid but often higher-yielding investment. Private debt could come in the form of a managed fund, or more direct lending methods.
Capstone’s Growth Fund is a private debt fund featuring Texas real estate and targets passive 10% returns. Our Fractional Loan Program, on the other hand, allows participants to choose individual loans on properties and become a first-position lien holder. You can actually be the lender without the all hassles of running a full-blown firm!
Let’s break down the different types of debt investments, who they’re best suited for, and what makes each appealing.
Real Estate Debt Investing
Aimed at: Investors seeking steady income and lower-risk opportunities.
How it works: Real estate debt investing involves lending money specifically for real estate projects, such as property developments or renovations. In return, the investor receives regular interest payments, typically secured by the property itself. This means that if the borrower defaults, the lender (investor) has the right to seize and sell the property to recover the investment.
Why it’s attractive: The loans are backed by a hard asset—real estate—making it less risky than unsecured loans. Investors typically enjoy predictable returns from interest payments, which makes it a popular choice for those nearing retirement or looking for passive income.
Distressed Debt Investing
Aimed at: High-risk-tolerant investors, often those with financial or legal expertise.
How it works: Distressed debt investing involves buying debt from companies or individuals in financial trouble, often at a steep discount. Investors can profit by either collecting on the debt or selling it for more than they paid, depending on how the borrower’s financial situation evolves.
Why it’s attractive: Distressed debt can be purchased for pennies on the dollar, leading to the potential for high returns if the borrower recovers. However, the risk is high—if the company or borrower defaults, investors may face lengthy legal battles or potential losses.
Convertible Debt
Aimed at: Investors looking for both downside protection and potential equity upside.
How it works: Convertible debt starts out as a loan, but under certain conditions, it can be converted into equity (ownership shares) in the borrower’s company. This means that if the company performs well, the investor can choose to convert the loan into shares and benefit from the company’s growth.
Why it’s attractive: It provides the security of debt (interest payments and the return of principal) with the potential upside of equity. Investors can choose to convert the debt into shares if the company is performing well, offering a hybrid investment model with both risk mitigation and growth potential.
Corporate Bonds
Aimed at: Conservative investors looking for predictable income (but relatively low returns) from large companies.
How it works: Corporate bonds are loans made to companies, where the investor earns regular interest payments (also known as coupons) until the bond matures. At maturity, the company repays the principal, and the investor receives their initial capital back.
Why it’s attractive: Corporate bonds provide a reliable income stream with less risk than stocks. Though they typically offer lower returns compared to higher-risk investments, the predictability of the interest payments makes them attractive to risk-averse investors.
Municipal Bonds
Aimed at: Tax-conscious investors seeking lower-risk, tax-advantaged income offered by city governments.
How it works: Municipal bonds (also known as "munis") are loans to local or state governments. In exchange, investors receive regular interest payments, and the income is often exempt from federal (and sometimes state) taxes.
Why it’s attractive: The tax benefits of municipal bonds can be highly attractive for individuals in higher tax brackets. Additionally, these bonds are relatively low-risk since they are backed by government entities, though returns are typically lower compared to corporate bonds or private debt.
Peer-to-Peer (P2P) Lending
Aimed at: Individual investors looking for maximum involvement and higher potential returns.
How it works: Peer-to-peer (P2P) lending involves using online platforms to lend money directly to individuals or small businesses. The platform connects lenders with borrowers, and investors earn interest on the loans they provide.
Why it’s attractive: P2P lending offers higher interest rates than traditional savings accounts or bonds, allowing investors to earn more on their capital. However, the risk of default is higher since P2P lending is often unsecured, and the borrower may not have access to traditional credit.
Fractional Loan Program (AKA Mortgage Note)
A Fractional Loan Program may also be referred to as mortgage note investing, trust deed investing, and private lending. All these terms may be used interchangeably.
Aimed at: High-net-worth individuals seeking steady returns on individual properties without having to scout out their own borrowers and service their own loans.
How it works: Participants lend money for individual loans. They own a fraction of an individual loan in a first-lien position. This is done through a firm that sources the borrowers, vets them, and services the loans. As the borrowers pay interest to the firm, you earn returns.
Why it’s attractive: Capstone’s Fractional Loan Program offers higher returns than public bonds, as investors are compensated for the illiquidity and risk involved. Yet it’s not nearly as stressful or involved as peer-to-peer lending because you have an experienced firm in between you and borrower – while still being a first-position lien holder. This allows you more control over your selections compared to a fund, while not requiring the know-how and risk of peer-to-peer lending or running your own lending business.
Capstone Capital Partners' Private Debt Offerings
With Capstone, you have two unique opportunities to get involved in real estate debt with confidence:
Capstone Growth Fund: This is a real estate debt fund in which investors pool their money to earn returns from interest payments on real estate loans. It's a passive investment option for those seeking diversified real estate debt exposure. Capstone manages the portfolio and you earn returns.
Fractional Lending Program: While not technically an investment, this program allows individuals to act as lenders by selecting specific loans to fund. Capstone handles all the heavy lifting: finding borrowers, servicing the loans, and ensuring the property’s ARV (After Repair Value) justifies the loan.
Ready to Explore?
We want you to find the debt vehicle that makes sense for your goals. Our offerings may not fit your goals, and that’s totally okay. If you’re seeking S&P 500 (or higher) returns, we aren’t a good fit. But if stable, 8-10% returns on hard assets is what you’re after, let’s talk.
We want you to feel comfortable and confident with your selection. If you’re located in the greater Austin, Texas area, we are more than happy to meet with you in person. Or, we can schedule a video call at your convenience.
The backbone of our firm is trust and experience. Read more about Capstone Capital Partners. See testimonials from our family of partners.
Fill out this short contact form and we’ll reach out to you!
