Real Estate Debt Funds: What it is, Returns, Risks, & More
Real estate debt funds provide investors with a way to earn significant returns with little risk. Learn more about whether they might work for you.
Real estate debt funds provide financing for a variety of real estate projects that might not have access to loans through traditional financial institutions like banks or credit unions. The capital for the loans typically comes from investors. A lender administers the fund, receiving funds from investors and making loans to borrowers. Hard money lenders are one of many types of lenders that accept real estate debt fund investments. This article describes real estate debt funds and the various forms they may take, identifies some of the largest funds in the country, and discusses when real estate debt investing might be a good option.
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What is a real estate debt fund?
A real estate debt fund uses capital from accredited investors to loan money to borrowers for real estate projects. Borrowers receive short-term financing, and investors get returns through regular interest payments.
How does a real estate debt fund work?
Many real estate projects are too high-risk for banks and credit unions, which prefer straightforward loans like mortgages on primary residences. Developers and experienced real estate investors need a source of capital. Hard money lenders and other private lenders meet this need. They make short-term, high-interest loans for real estate projects, with the real property serving as collateral. The capital for these loans comes from investors who deposit money in a real estate debt fund.
In exchange for providing the capital to fund loans, investors receive regular interest payments over the life of the loan. The lender returns the loan balance to the investor at the end of the loan term. Since the real property secures the debt, the risk is fairly minimal.
This is not a lengthy commitment for investors. While mortgages may last for 15 or 30 years, the terms for loans from real estate debt funds typically range from 8 months to 2 or 3 years. The returns can be significant, though, because of the high interest rates on the loans.
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How is a real estate debt fund structured?
The structure of a real estate debt fund is important because of federal and state securities laws. This can affect lenders and investors in at least two significant ways.
First, an investment in a real estate debt fund is a “security.” A lender seeking investors must either register with regulators like the U.S. Securities and Exchange Commission (SEC), which can be a cumbersome process, or demonstrate that they are exempt from registration. Limiting investment to accredited investors allows lenders to maintain this exemption. Federal securities regulations define an “accredited investor,” in part, as an individual who meets minimum criteria regarding income, assets, or investing experience.
Securities laws also impose different requirements on different types of investment funds. Real estate investment funds (REITs) are at the most complicated end of the scale with the most onerous regulatory requirements. Lenders establishing real estate debt funds generally prefer to remain at the opposite end of the scale. They tend to structure funds in relatively simple ways that protect investors from liability, such as a limited partnership or limited liability company.
What is a no-load real estate debt fund?
A no-load fund does not charge investors a sales fee or commission. When a broker or other third party sells shares in an investment, they might charge a fee to the investor, known in this context as a “load.” This leaves less money to go into the actual investment, which reduces the investor’s total returns.
When an investor puts money into a no-load fund, they can be assured that 100% of their investment will be working for them. Any fee that the lender charges comes out of the returns paid to the investor.
The majority of investment funds are no-load. This includes most real estate debt funds.
What is a commercial real estate debt fund?
While many funds make loans for a variety of real estate projects, commercial real estate debt funds exclusively loan money for commercial projects. This might appeal to investors who want the potential for higher returns because of specific aspects of the commercial real estate business.
Residential real estate tends to be fairly predictable, at least in comparison to commercial properties. It typically consists of single-family homes or condominiums. The goal of a residential project is usually either a fix-and-flip or a long-term rental.
Commercial real estate presents far more options in terms of development, lease terms, and sales. Lenders and borrowers often have more flexibility in how they structure loans for commercial projects, provided they are willing to accept greater risk. Investors who are also willing to accept more risk may be drawn to commercial real estate debt funds.
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What are the largest real estate debt funds?
Precise figures about the size of real estate debt investments can be difficult to come by. A publication known as Private Equity Real Estate publishes an annual list of the top 50 firms based on the amount of capital raised during the year for real estate debt funds. Paris-based Axa Investment Managers tops the list with nearly $21.2 billion. The top five U.S.-based fund managers are as follows:
PGIM Real Estate, Newark, NJ, $19.918 billion: While the name PGIM might not be immediately recognizable, it is a subsidiary of insurance giant Prudential. This likely makes it appealing to many investors.
Blackstone, New York, NY, $13.600 billion: Blackstone describes itself as “the world's largest alternative asset manager,” with a portfolio totaling more than $1 trillion.
Goldman Sachs Asset Management, New York, NY, $9.036 billion: Anyone who is familiar with the financial sector of the U.S. economy knows the name Goldman Sachs.
PIMCO, Newport Beach, CA, $8.936 billion: This company began as part of Pacific Life Insurance Company. It is now a subsidiary of the German financial services firm Allianz.
Affinius Capital, San Antonio, TX, $7.884 billion: Affinius Capital began as “the real estate investment arm of USAA,” the San Antonio-based financial services company. It took its present form — and name — in 2023.
All of the companies listed here are part of or affiliated with titans of the global financial world. Investors may choose these firms because of their reputations or long track records of success. Investing with a large firm like any of the above has drawbacks, though. For example, many of the largest financial firms have minimum investment requirements that exclude anyone with less than a high-six–figure or seven-figure amount to invest in a debt fund.
A smaller private real estate debt fund can offer advantages that bigger firms cannot. A small fund might take investors who meet the SEC’s definition of an accredited investor but don’t want to put $1 million or more into a single fund. It can offer individual, hands-on attention for investors who are just getting started, or who want to put their money into smaller projects or projects located nearby.
Learn more
Real estate debt investments offer passive returns with small risk. Capstone Capital Partners’ trust deed and first lien investments target returns of 8 to 9% net annual yields. We offer hyperlocal investments for Texas investors. To learn more about our investment opportunities, please contact the Capstone team today through our online contact form.
