Amidst a continually fluctuating macroeconomy with shifting interest rates, lending regulations, and the like, capital allocation has become a key focus of most commercial real estate investors and participants. Recent bank policies turning away from CRE lending given the uncertainty regarding capital requirements has left a gap in the CRE lending landscape that alternative capital sources are able to fill. Enter CRE debt funds – and their recent spike in popularity.

In fact, CRE debt funds are seeking to raise an additional ~$50 billion in capital over the near term, according to Commercial Mortgage Alert, a Green Street news publication. Over the last decade, CRE debt funds have nearly doubled in size from an estimated $65 billion to ~$125 billion. Today, these funds primarily originate short-term (~3-5 year), floating rate loans at spreads (~300-550 bps) that are significantly wider than their alternatives.

Now, back in the days of the Global Financial Crisis (GFC), these debt funds rose to their original popularity due to their “regulatory arbitrage” that required banks to hold 1.5x higher equity against them as opposed to more stable assets. This allowed debt funds to step in and fill the hole left by banks that was filled by Blackstone, Starwood, Apollo and the like.

Today, in an environment with uncertain regulatory capital requirements, a pull back from banks that echoes the GRC, and pessimistic risk profiles across multiple sectors, these debt funds are increasing in popularity yet again. And even though there are still constraints holding debt funds back from their big boom, such as their focus on transitional real estate assets as opposed to more stable income producing properties, their significant growth seems inevitable at this point.

This growth seems to be impending, but it is far from an easy road at this point. But that’s not to say that the juice isn’t worth the squeeze.

In fact, there is currently 4x the size of all debt funds assets sitting on bank balance sheets that rests perfectly in debt funds’ target zone. Not to mention just how much dry powder these debt funds are currently sitting on.

The primary issue holding CRE debt funds back is that they are traditionally a key source of capital for transitional CRE projects. After a project reaches a stabilized point, the sponsors tend to “grow out” of the CRE debt fund world and graduate to more lower-cost, long-term sources of financing. But even this roadblock is currently being worked on by certain big-name joint ventures in the debt fund market.

All signals seem to point towards growth for CRE debt funds as an increasingly more reliable and long-term source of financing in the constructional project world as it graduates towards more stabilized projects.

And as the assets managed continue to evolve into more long-term investments, so to will debt funds’ deployment and equity.

To learn more about the origin, past, and future of CRE debt funds, read Green Street’s latest report on “Private “CREdit” in the client research library to see the opportunities that lie in these alternate funds.

Learn more about CRE debt funds by requesting a sample report or talking to a CRE specialist on Private Credit today.