Accrued interest is the interest on a loan accumulated over a period of time either as an expense (for the borrower) or revenue (for the lender) and paid at maturity or final payoff.
- Accrued interest is a general finance concept. In real estate, it applies mostly to debt and bridge financing instruments.
- The concept is important to consider for individual investors, as it carries implications for cash flow timeline.
- In the case of EquityMultiple’s investments, accrual usually takes place on a monthly basis over a period of 9 to 36 months depending on the term of the investment.
In the case of some real estate debt instruments and other bridge financing, it can provide the borrower with flexibility – with respect to the repayment schedule – while offering the lender or investor a more attractive total return. Many of EquityMultiple’s preferred equity investments offer both a current preferred return and a total, accrued return, which effectively functions as accrued interest.
Accrued Interest – What it Means for Investors
The period of time in which interest accrues is a critical detail, both for lenders (investors) and borrowers. A feature of some single-family home mortgages is accrual of interest over the each day of a standard monthly billing period; timely monthly payments in this case save the mortgage borrower interest that would otherwise accrue throughout the month. In the case of EquityMultiple investments, the accrual typically takes place over the course of the term, and is assessed to the borrower (and delivered to investors) as a form of accrued return during the latter periods of the investment or as a single distribution at exit.
Like IRR, “accrued interest” is a term used generally throughout the realm of finance, including in reference to the bond market. In real estate, the term carries particular relevance, applying most heavily to debt and bridge financing instruments. It is an important concept for individual investors to understand, as it pertains to the cash flow profile of the investment. In our investor documents, we will explicitly call out the breakdown and schedule of current distributions versus accrued interest.
For more on accrued interest and accounting principles, please refer to this article.