Fortifying Portfolios With Private Real Estate Credit

Private commercial real estate credit fundraising has nearly quadrupled over the past 15 years. We expect regulatory and economic trends to continue to provide compelling opportunities to nonbank real estate lenders.
Investors in private real estate credit can benefit from income, portfolio diversification and downside mitigation.
Managers can employ various types of financial and structural leverage, and it is important for investors to weigh the risks and benefits of each.
To best capitalize on these opportunities, we believe investors should seek managers with robust deal-sourcing pipelines, sufficient leverage management, thorough due diligence, ownership understanding and significant structuring experience.

Filling the Void

At any point during an economic cycle, owners of real estate will need access to capital—whether to develop, acquire or refinance assets. What has shifted over time is where they get this financing. Historically, banks dominated the real estate loan market. Then, the Global Financial Crisis of 2007-2008 changed everything.

After the crisis, Congress strengthened underwriting standards and increased bank regulation. As banks retreated from the market, private real estate lenders began filling the void for midsize companies that needed financing and for large borrowers seeking more flexible financing terms. The industry has also been consolidating, with the number of U.S. commercial banks dropping by nearly half between 2000 and 2022 and counting (see Figure 1).

Figure 1: Bank Industry Consolidation Shifts More Lending to Private Credit

Source: FDIC, as of December 31, 2023.

More recently, soaring inflation in 2022 and the aggressive interest rate hikes to tame it pressured bank margins. After the regional bank crisis in early 2023 led to additional regulatory reform proposals to strengthen large U.S. bank oversight, commercial real estate lending became even less attractive for banks.

As a result, banks turned away from even more of these lending opportunities. Nonbank lending skyrocketed and expanded the universe of private real estate debt opportunities for investors—a trend that shows no signs of slowing. Indeed, fundraising has nearly quadrupled in the past 15 years, from approximately $8 billion per year from 2009-2011 to almost $31 billion a year from 2021-2023.¹

Here, we explore what’s driving this long-term growth, discuss potential benefits and risks of adding private real estate credit to an investment portfolio, explain the various debt and leverage strategies involved, and highlight the key attributes that we believe investors should consider when evaluating managers.

What's Fueling Growth in Private Real Estate Credit?

Private commercial real estate credit is in high demand around the globe. According to Real Capital Analytics, approximately 15,000 unique buyers globally have purchased commercial real estate properties over the past 24 months, and the majority have tapped private real estate credit for financing.

The real estate credit market has grown exponentially over the past 20 years, with over $6 trillion in commercial real estate debt outstanding in the U.S. alone.² During this time, sources of capital in this vast asset class broadened significantly compared with the era when credit was concentrated at banks.

Between October 2023 and October 2024, commercial real estate loan volume originated by alternative lenders rose 34%, while traditional bank lending fell 24% (see Figure 2).

Figure 2: Alternative Lenders Boost Commercial Real Estate Loan Market Share as Banks Retreat

Source: RCA Newmark Research, as of October 2024.

Looking ahead, two major factors are likely to maintain the nonbank lending momentum over the next few years: A significant amount of debt is coming due that will need to be refinanced, and a large amount of private equity dry powder is waiting to be deployed to new investment opportunities.

For example, between 2025 and 2028, $4.5 trillion in commercial real estate debt is scheduled to mature (see Figure 3). As banks continue to be capital-constrained, borrowers will likely need to seek refinancing capital from nonbank lenders that can provide faster, more efficient and more holistic solutions.

Figure 3: Upcoming Maturities Should Drive Private Credit Refinancing Opportunities

Source: S&P Global, as of August 2024.

Meanwhile, value-add/opportunistic private equity real estate firms held nearly $380 billion of undeployed capital at the end of 2024 (see Figure 4).³

Figure 4: Private Equity Real Estate Firms Are Ready to Deploy Billions in Dry Powder

Source: Preqin, 2025.

What are the Investor Benefits of Real Estate Private Credit?

Private real estate credit can be an attractive component of an investment portfolio, offering stable income, lower correlation with broader markets and potentially higher returns compared with traditional fixed income investments, among other benefits.

Diversification

Commercial real estate credit can help diversify portfolios because it is the only form of lending that has a low correlation to both traditional fixed income securities, such as government and corporate bonds and loans, and traditional real estate equity (see Figure 5). While real estate loans are closely tied to property market conditions, rental income stability and individual borrower credit risk, government and corporate bonds/loans are influenced by interest rates, economic conditions and an issuer’s credit risk.

Figure 5: Low Correlation to Traditional Fixed Income Enhances Diversification

See endnote 4.

Income potential

Commercial real estate lenders can often secure higher loan origination fees and coupon rates from borrowers compared with lenders of more-liquid fixed income alternatives, which tends to enhance real estate credit yields (see Figure 6). Meanwhile, recurring coupon payments help reduce risk because investors receive monthly income rather than waiting until the loan matures to be fully repaid.

Figure 6: Real Estate Credit Yield Often Exceeds Traditional Fixed Income

See endnote 5.

Low loss ratio

Because commercial real estate credit is secured by physical properties, lenders may seize and sell the assets to recover losses if a borrower defaults. This tangible collateral offers investors a layer of security (i.e., a lower long-term loss rate) not always found in traditional fixed income investments (see Figure 7). Lenders with owner-operator expertise have an advantage because they can take over the underlying collateral property and seek to maximize recovery in the event of foreclosure.

Figure 7: Commercial Real Estate Debt Has Lower Delinquency Rates Over Long Periods

Source: St. Louis Fed FRED (CORBLACBS) and (CORCREXFACBS).

Total return

Commercial real estate credit often delivers higher yields compared with government bonds or investment-grade corporate bonds, contributing to historically strong returns across market cycles (see Figure 8).

Figure 8: Real Estate Credit Has Been a Top Debt Performer on Average Over the Last 10 Years

See endnote 6.

Downside mitigation

For debtholders, the equity cushion embedded in private real estate loans acts as a buffer against changes in property value. If property values decrease, lenders are less likely to incur a loss because the equity investor absorbs any loss before the debt is affected. If property values increase, lenders’ equity buffer against potential loss rises in tandem. Today’s real estate environment highlights this benefit; prices have reset, which means managers can lend at a discount to a property’s intrinsic value. When lending at an attractive basis, the uncaptured value in the property provides additional protection to a lender’s position.

As evidenced over long periods of time (see Figure 9), real estate debt has demonstrated resilience in market crises. If you were a lender in the senior portion of the capital structure (lower loan-to-value band), the value of your collateral was largely insulated from market downturns over the last 50 years. If you were a lender in the mezzanine portion of the capital structure (higher LTV band), real estate value declines have had an impact on your position only twice. However, given the asset class’s resilience and track record of quick value recovery, mezzanine lenders had the opportunity to preserve value through workouts and loan restructures.

Even during recent real estate value corrections, mezzanine lenders’ positions were largely insulated (see Figure 9). For example, a lender who originated a loan in December 2021 would have seen a nearly 30% drop in the collateral property’s value over the loan’s three-year term. Assuming the loan was originated at a 65% LTV, the decrease in property value would not have affected the lender’s position. In fact, the equity cushion built into the capital stack would have allowed for a further ~10% decrease in property value before the lender’s position experienced a decrease in value.

This highlights the importance of working with a manager who has the real estate equity and structuring expertise necessary to work through these types of acute scenarios.

Figure 9: Mezzanine Positions Tend to Be Insulated From Declines in Real Estate Property Values

Source: NCREIF Index quarterly reporting, December 2024.

How Does Private Real Estate Credit Work?

Investors can access real estate credit through both the public and private markets. In the public markets, they can directly purchase commercial mortgage-backed securities issued by banks. Alternatively, qualified investors can invest in private real estate credit funds, which originate loans on behalf of limited partners.

Unlike traditional bank loans, private real estate loans are negotiated directly between nonbank lenders and borrowers. These lenders include private equity firms, hedge funds, insurance companies, pension funds and other institutional investors.

While this form of credit typically does not trade publicly or receive agency debt ratings, it plays a crucial role in real estate markets by offering flexible financing solutions tailored to the specific needs of borrowers and their projects.

Private real estate credit borrowers commonly use their loan proceeds for:

Commercial property acquisition: Purchases often include multifamily housing, office buildings, retail centers and industrial facilities. These acquisitions involve either stabilized properties (i.e., completed or renovated with high occupancy and steady cash flow) or transitional properties (i.e., in need of renovation, repositioning or additional leasing to reach a stabilized level).
Development: Building or redeveloping those same types of commercial real estate is another common use.
Refinancing: Refinancing existing debt with private credit gives borrowers access to additional capital and potentially better loan terms (depending on the market environment). This also provides a runway to borrowers who are not ready to sell or are long-term holders.

Investors can choose among various types of private debt within the capital stack, which is a financial structure that defines which stakeholders have the rights to a transaction’s income and profits, and the repayment hierarchy if the borrower defaults. Each one of the debt (and equity) strategies within the capital stack offers a different mix of risk and reward (see Figure 10):

Mortgage loans: Also referred to as senior debt, mortgage loans are the lowest-risk type of private real estate credit. They are secured with the borrower’s collateral, and investors are repaid first if the borrower defaults. While their interest rate payments and defined terms offer investors predictability, they also limit upside.
Mezzanine loans: These loans allow lenders to convert the debt they hold into equity if the borrower defaults. In a default, mezzanine debt holders get repaid after mortgage loan holders but before equity investors. Mezzanine loans pay investors higher interest to compensate for the elevated risk and tend to attract investors seeking higher returns than mortgage loans pay.
Whole loans: These loans combine aspects of mortgage loans and mezzanine loans. While they are first in line to receive loan repayments, whole loans are also closer to equity in the capital stack than traditional mortgage loans. Whole loans are typically sized large and priced between mortgage and mezzanine loans. (Note that whole loans represent the entire capital stack when the stack is not split up.)
Preferred equity: These investments combine characteristics of debt and equity. Preferred equity is subordinate to mortgage and mezzanine loans but senior to common equity in a default. Investors in preferred equity typically receive fixed dividends or priority distributions from the real estate project’s cash flows. Preferred equity tends to attract investors who are looking for more security than traditional real estate equity ownership provides.
Equity: Also known as common equity, this investment simply represents a share of ownership in a property. It sits at the bottom of the capital stack, meaning equity holders are liable to the debt holders in the event of underperformance.

Figure 10: Private Real Estate Credit Strategies Offer a Varying Mix of Risk and Reward

With the debt capital stack broken up into various debt types, private real estate credit investors can choose the appropriate investment to seek returns in line with their risk/reward tolerance. At the same time, borrowers can attract more capital from a more diverse set of investors.

How Do Private Fund Managers Use Leverage?

Because of the relative stability of the underlying loans, private fund managers may seek to enhance returns by incorporating debt from outside sources into their real estate credit strategies. This can include syndication of a senior debt position to a co-lender (structural leverage, see Figure 11A ), or a loan from a third-party lender to fund an investment (financial leverage, see Figure 11B):

Senior syndication (structural): Two or more lenders jointly provide funds to a borrower to spread the risk (see Figure 11A). The “senior” lender holds the priority portion of the loan amount and gets paid first if the borrower defaults. The “junior” lender is subject to higher risk but can benefit from higher returns.
Collateralized loan obligations (CLOs) (financial): The lender bundles multiple commercial real estate loans and sells the package as a security to other investors.
Loan-on-loan financing (financial): The lender provides financing to a single borrower and enhances the investment returns by obtaining financing with a lower-rate loan from another provider.
Crossed-facility financing (financial): The lender provides multiple loans to one or more borrowers and in turn finances these debt positions by obtaining a lower-rate loan from another provider. These loans are used as collateral for the crossed facility.

Private fund managers often turn to banks to provide third-party lending for these leverage strategies. While banks have retreated from originating commercial real estate loans because of strict regulations and slim profit margins, many of them still want to participate in the sector and are willing to offer third-party leveraged loans at favorable terms.

Figure 11: How Managers Can Incorporate Leverage Into a Commercial Real Estate Loan

Fund managers earn a premium on these transactions by capturing the difference between the interest income they earn on their original loan and the favorable borrowing costs they pay to third-party lenders. In other words, using leverage can increase the return a manager earns on a transaction (using less fund capital to do so) without changing the original loan’s terms or the borrower’s experience. Additionally, by employing leverage and holding a smaller direct investment in a loan, fund managers effectively free up capital, enabling them to further diversify their portfolios by investing in additional loans.

While leverage can be a powerful tool to boost returns, it also adds potential risk to a portfolio (see Figure 12). These risks can include:

Mark-to-market risk: The leverage provider can request a partial repayment or deleveraging if the underlying loan investment decreases in fair value.
Match-term risk: If the investment is longer-dated than the term of the leverage, then the borrower may need to refinance or come up with capital to fund repayment.
Recourse risk: The leverage provider could request a guarantee for a percentage of the total leverage, to the extent there are losses.
Cross-collateralization risk: When the leverage provider finances several underlying loan investments in a crossed facility, a single underlying loan default could create complications for the rest of the portfolio, such as requiring the borrower to pay down a portion of the facility.

Figure 12: Risks Associated With Use of Leverage

It’s critical for investors to thoroughly understand the manager’s leverage strategy and make sure it aligns with their risk profile. The market for structural and financial leverage continues to evolve and remains highly customized based on preference. The terms above illustrate the most standardized set of terms, which may be negotiated.

How Should Investors Assess Private Real Estate Credit Opportunities?

Because of the relationship-based nature of private commercial real estate lending and the customized loan characteristics, properly sourcing, underwriting, structuring and monitoring these investments is critical. That’s why we believe it’s important for investors to closely evaluate their potential fund managers with a focus on the following key attributes.

Robust deal-sourcing pipelines

Increased competition for commercial real estate loan opportunities means established firms with large origination platforms and strong deal-sourcing pipelines have a significant advantage over newer, smaller firms with less-robust platforms. They can also benefit from differentiated deal flow and potentially offer investors more access to attractive alternative sectors like student housing, single-family rental, storage and life sciences. Managers should demonstrate consistent access to diverse lending relationships across market cycles.

Sufficient leverage management

While loan originators may use leverage offered by commercial banks to amplify returns, the term of the leverage facility and that of the loan’s underlying assets are often mismatched. This can create leverage refinancing risk. Leverage providers also may demand quick repayment when asset values fall in a downturn, magnifying liquidity problems. Fund managers with extensive experience in the capital markets are better positioned to mitigate these risks and obtain new financing as needed.

Thorough due diligence

Private commercial real estate lending requires extensive research normally associated with private equity real estate investments. While private real estate lenders must have the proper staff and resources to conduct this research, investing in alternative sectors also requires sector-specific expertise. Lenders who are also owner/operators not only have this expertise, but they are also able to step in to manage the asset if the borrower defaults.

An appropriate investment structure

Commercial real estate lenders without structuring expertise or with narrow investment mandates may lack the flexibility and creativity to adapt to borrowers’ needs, leaving them unable to seize attractive opportunities or design financing structures to maximize risk-adjusted returns. Fund managers should provide the necessary resources to properly address the legal, tax and regulatory concerns that often arise when setting up customized structures.

Significant restructuring experience

Commercial real estate lenders with limited experience navigating distressed situations and challenging economic environments may lack the skills needed to identify early signs of borrower distress, help those borrowers regain financial stability or recover maximum value if an investment falters. Successful fund managers should continuously and rigorously monitor their investments to address problems early, and they should have a history of offering effective loan workouts with favorable covenants to mitigate default risk.

More To Come

While banks are still a major player in the real estate space, private commercial real estate credit has emerged as one of the fastest-growing sectors in the financial industry over the past 15 years.

We expect nonbank lenders to continue to find compelling private real estate credit opportunities. The global regulatory environment for banks remains stringent, so the ability for private lenders to provide flexibility and access to financing should continue to come at a premium. Additional tailwinds include the looming debt maturity wall that offers enormous refinancing opportunities, along with the billions in dry power that private equity companies are looking to deploy for attractive real estate transactions.

Together, these trends have created an optimistic outlook for private commercial real estate credit that should benefit lenders, borrowers—and importantly, investors—for decades to come.

^Endnotes:

^{1. Preqin.}
^{2. Trepp, May 2024.}
^{3. Preqin, 2025.}
^{4. Note: 10-year timeframe CY 2014–2023. RE Credit = Gilberto Levy 2 High Yield Real Estate Debt Index, Dir. Lending = Cliffwater Direct Lending Index (CDLI). Inv. Grade = Bloomberg U.S. Agg Bond Index. CMBS = Bloomberg US CMBS Investment Grade Index. High Yield = Bloomberg U.S. Corporate High Yield Index. Lev. Loans = Morningstar LSTA US Levered Loan Index. Treasuries = Bloomberg U.S. Intermediate Treasury Index. Core RE Equity = NCREIF Property Index (NPI).}
^{5. Note: Past performance does not guarantee future results. Represents 10-year annualized income yields/interest returns for each asset class as of September 30, 2024. Direct Lending = Cliffwater Direct Lending Index as of June 30, 2024. Core Real Estate Equity = NCREIF Property Index (NPI). High Yield = ICE BofA U.S. High Yield Index. Leveraged Loans = Credit Suisse Leveraged Loan Index. Investment Grade Bonds = Bloomberg U.S. Aggregate Index. CMBS = Bloomberg US CMBS Investment Grade Index as of June 30, 2024. Treasuries = Bloomberg U.S. Intermediate Treasury Index as of June 30, 2024. Real Estate Credit = Gilberto Levy 2 High Yield Real Estate Debt Index as of June 30, 2024. The indexes are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Source: Cliffwater, ICE BofAML, Credit Suisse, Bloomberg, S&P LCD, Gilberto-Levy.}
^{6. Source: RE Credit = Gilberto Levy 2 High Yield Real Estate Debt Index. Dir. Lending = Cliffwater Direct Lending Index (CDLI). Inv. Grade = Bloomberg U.S. Agg Bond Index. CMBS = Bloomberg US CMBS Investment Grade Index. High Yield = Bloomberg U.S. Corporate High Yield Index. Lev. Loans = Morningstar LSTA US Levered Loan Index. Treasuries = Bloomberg U.S. Intermediate Treasury Index. Core RE Equity = NCREIF Property Index (NPI).}

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