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Private debt

Key Takeaways

Private Debt

Private debt in real estate involves direct lending between non-bank lenders and real estate stakeholders as well as purchasing of securitized debts, with funds pooled from investors.

Capital stack

A capital stack refers to the combination of different sources of funding that a real estate or investment project uses to finance its development or acquisition. Understanding the capital stack is very important for investors and lenders because it allows them to assess the risk-return profile of the investment, make informed financing decisions, and allocate capital efficiently. 

Main Drivers

Maturing loans, pullback from traditional lenders, and the higher-for-longer interest rate regime are the main secular drivers for the sector.  

What is Private Debt?


Private debt involves direct lending between borrowers and non-bank lenders such as private equity firms, credit funds, or institutional investors, as well as acquiring securitized debt. Unlike traditional lenders, such as Banks, that comprise nearly 40% of the outstanding commercial and multifamily mortgages, real estate debt funds pool capital from investors to carry out such investment activities.  

A commercial loan is a financial arrangement where a property owner or developer borrows money from a lender to fund commercial real estate properties. Typically, the property serves as collateral for the loan in case the borrower defaults on the loan. In some cases, additional recourse from a borrower is required by the lender to secure the loan.

Composition of Owners of US Commercial and Multifamily Mortgages as of Q3 2023 ii 

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Key terms used in the sector​

Loan Amount and Terms

Loan Proceeds are determined based on factors such as the property's value, the borrower's creditworthiness, and the property’s financial statements. Loan terms include the principal amount, interest rate, repayment period, and any other specific conditions agreed upon between the borrower and lender.

Loan-to-Value (LTV) Ratio

LTV compares the loan amount to the appraised value of the property at origination. A lower LTV ratio indicates a lower risk for the lender. Commercial real estate LTVs typically range from less than a third to two-thirds of the capital stack. LTVs do not assume the value of planned capital improvements. 

Interest Rates

Commercial real estate loans may have fixed or variable interest rates. Fixed-rate loans maintain a constant interest rate throughout the loan term, providing predictable payments. Variable-rate loans have interest rates that are tied to a reference rate, such as Prime Rate or Secured Overnight Financing Rate (SOFR) which adjust periodically based on market conditions. 

Loan Covenants

Lenders may include loan covenants, which are conditions or restrictions that borrowers must adhere to during the loan term. These may relate to financial performance, property management, or other factors. Covenants are not uniform and vary by lender, property, and identified risk factors. 

Who are the borrowers of private debt?


Real estate owners and developers are the primary borrowers of private real estate debt to secure financing for property development or operational needs. The use of loan proceeds can range from property acquisitions, construction activities, or in some cases capital improvements. Loans can take on different forms, and one may invest in direct and/or conduit structures. Unlike conventional lenders, private debt can be tailored to specific project requirements without conforming to external regulations.

What are the secular drivers for the sector?  

  • Pullback from traditional lenders: The demand drivers for private debt are influenced by evolving regulatory changes in the commercial banking sector. Recent proposed regulations are likely to reduce the availability of capital from conventional bank lenders, which will drive demand to other non-bank institutions including private debt funds. 

  • Maturing loans: over $1 trillion in real estate loans is scheduled to mature in 2024 and 2025, of which nearly 35% are multifamily loans.iii Amid tighter credit conditions, which generally refers to higher interest rate environment with stricter covenants, private lenders and other non-bank lenders are likely to have access to a broader pool of high quality borrowers.

  • Higher-for-longer interest rate regime: Tight credit conditions coupled with near-term loan maturities facing a higher interested rate environment may result in non-bank lenders’ capacity to provide flexible loan vehicles structures that allow for recapturing asset value through moderate capital market dislocation.    

Examples of Capital Stack in Commercial Real Estate Financing

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What are the Common Subclasses?  

  • Senior Debt: Senior secured loans involve lending money to a real estate project with the property serving as collateral. These loans have the highest priority in case of default, providing a lower-risk profile compared to other debt instruments.

  • Mezzanine Debt: Mezzanine debt represents a subordinated loan that sits between senior debt and equity in the capital stack. It typically has a higher risk and return profile for lenders and their investors.

  • Preferred Equity: Preferred equity involves an ownership stake in a property with preferential treatment in terms of cash flow distribution and proceeds during a sale. It combines elements of debt and equity, providing a balance of risk and returns.  

  • Securitized Products: Structured debt products such as Commercial Mortgage-Backed Securities (CMBS), Commercial Real Estate (CRE) Collateralized Loan Obligations (CLOs) etc. are financial instruments that pool commercial real estate loans. Lenders typically bundle loans to create securities with tranches based on levels of risks. These are then traded in secondary markets where investors purchase portions of these securities, receiving income from the underlying mortgages and exposure to diversified pool of commercial real estate assets. The performance of the asset class is influenced by factors like property values, rental income, and economic conditions. Single Asset Single Borrower (SASB) CMBS are a variation of this structure where a single property serves as the collateral for a securitized investment product.

Glossary of Terms 

Capital Stack: The capital stack is the financial structure of a commercial transaction. It includes all financing instruments, such as debt and equity, and who has rights to the property's income and profits.

Commercial Mortgage-Backed Securities (CMBS): Commercial mortgage-backed securities (CMBS) are fixed-income investments backed by mortgages on commercial properties rather than residential real estate. CMBS are backed by longer-term fixed-rate loans.

Commercial Real Estate (CRE) Collateralized Loan Obligations (CLOs): CRE CLOs are structured as a hybrid of traditional leveraged bank loan CLOs and commercial mortgage-backed securities (CMBS). CRE CLOs are backed by shorter-term, floating rate CRE loans on transitional properties.

Loan Covenants: A loan covenant is a clause in the loan agreement stipulating the terms and conditions of loan policies between a borrower and a lender.

Conduit Structure: Conduit financing is a type of commercial real estate loan that involves pooling similar commercial mortgages together and selling them on the secondary market. Conduit loans are also known as CMBS loans.

Loan Securitization (B-Note Pari Passu): In a pari passu structure, a sponsor may split a CMBS loan into A-notes and B-notes. B-note is a form of subordinate financing that is secured by the same mortgage as an A-note but is subordinated to it under an Intercreditor Agreement.

Loan-to-Value Ratio (LTV): Loan-to-value ratio is a financial term that compares the amount of a loan to the appraised value of a property. It's calculated by dividing the principal of a mortgage loan by the value of the property.

Market Dislocation: A financial market dislocation is a situation where financial markets are unable to correctly price assets in both absolute and relative terms due to stressful macro or market-related conditions. 

Prime Rate: The prime rate, as reported by The Wall Street Journal's bank survey, is amongst the most widely used benchmark in setting home equity lines of credit and credit card rates. It is in turn based on the federal funds rate, which is set by the Federal Reserve.

Secured Overnight Financing Rate (SOFR): The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.

Securitized Debt: Securitization is a process that involves transferring mortgages or loans to third parties by issuing debt that is backed by the original debt pool's cash-flows.

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