Real Estate Debt Funds Allow You to Earn Passive Income With Less Risk

If you wan to invest in a real estate debt fund or secure capital from one, we’re breaking down what they are and how they work here.

Jennifer Farrington - Author

Feb. 15 2023, Updated 8:41 a.m. ET

Real estate debt fund closing.
Source: Getty Images

When a developer or real estate investor needs short-term capital to either purchase a new property or complete a project, they may be limited to who they can turn to for it. That’s where real estate debt funds come in.

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A real estate debt fund is created using private equity-backed capital that provides money to those in the real estate market, typically property owners who control commercial assets or even developers. If you’re considering investing in a real estate debt fund or want to secure capital from one, keep reading as we break down what they are and how they work.

What are debt funds in real estate?

Developer receives loan from real estate debt fund.
Source: Getty Images

A debt fund is a source real estate asset owners can go to when they need quick capital, whether it be for a construction project or to expand their real estate portfolio. Those who turn to debt funds often don’t qualify for traditional lending from banks or firms due to their credit rating or tricky financial situation.

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An ideal candidate for a debt fund loan might be a developer who is building a shopping center or someone who is in the process of selling an investment property but needs funding in the meantime to purchase another.

How does a debt fund work?

Let’s say you need capital to restore an apartment building but don’t qualify for traditional funding. After finding a fund (which is backed by private investors) and thoroughly researching its manager, you take out a loan from it to complete the project. Not only will you be charged interest on your loan, which usually starts at nine percent, but you might also be required to pay certain fees, some of which include:

  • Origination fee
  • Servicing fee
  • Exit fee
  • Modification fee
  • Extension fee
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Not only will you need to make monthly payments on your loan, but you’ll also need to put up collateral (usually the title to the property) in order to secure it. This allows the lender to mitigate their risk in the event you default on payments. And if you do, the debt fund would be entitled to obtain possession of the property.

What are examples of debt funds?

Debt funds are distributed by investment firms, some of which might center their focus on this type of lending. The three most common types of debt fund loans given out include bridge loans, rehab loans, and construction loans. Bridge loans are typically given out to those in the middle of a transaction, such as selling a home, but need money to continue with projects or investments.

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A rehab loan might work for someone remodeling a shopping center or office building, whereas a construction loan would work well for developers building a large space from the ground up. Some of the private real estate debt fund firms that raised the most capital in 2022 include:

  • Blackstone
  • Cerberus Capital Management
  • AllianceBernstein
  • LaSalle Investment Management
  • Berkshire Residential Investments
  • Goldman Sachs Asset Management Real Estate
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A property's floor plan before being built.
Source: Unsplash
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Are debt funds a good investment?

If you’re looking for a way to make passive income with minimal risk, real estate debt funds could be a good investment for you. Debt fund investors make their money from the interest charged on a loan, and payments are usually paid monthly or quarterly.

Although your profits may not be as high as someone who invests in the equity of a property, the risk is substantially lower, and there is less work involved.

Another important factor to point out once again is that if a borrower defaults on the loan they received from a debt fund, they lose the collateral, which can then be used for investors to recoup a profit.


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