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Banks and Debt Funds: A Powerful Partnership in CRE Finance
Traditional lenders and alternative lenders are combining to capitalize on opportunities that might otherwise go untapped.
In recent years, the commercial real estate financing landscape has witnessed a significant shift, with alternative lenders — often structured as debt funds — gaining traction. What started as a niche offering has now become a mainstay of the CRE market, with debt funds offering loans tailored to traditional bridge and construction loan opportunities.
With their ability to structure creative yet sound financing solutions, alternative lenders have become indispensable in helping developers navigate today’s dynamic real estate environment. In fact, according to CBRE, in the fourth quarter of 2024, alternative lenders, including debt funds and mortgage REITS, accounted for 23% of non-agency CRE loan closings. Debt funds led the segment with a 72% year-over-year increase in origination volume.
While credit unions and banks remain central to the industry, debt funds have emerged as valuable partners, offering complementary capabilities that enhance the options available to borrowers. This partnership is not merely transactional; it reflects a strategic alignment where the strengths of one entity amplify the capabilities of the other. This dynamic has made debt funds particularly effective lenders that can provide tailored solutions.
Defining Debt Funds
Debt funds, typically private investment vehicles, pool capital from various investors to offer loans to borrowers. These funds can be structured to offer more flexible terms compared with traditional lenders, allowing them to tailor loan structures to specific project needs. These partnerships generally involve debt funds providing specialized financing where traditional lenders may not be willing to take on the risks.
Debt funds reflect a growing demand for alternative financing options in CRE, as traditional lenders become more cautious in response to market volatility and economic uncertainty. With high interest rates, tightening regulations and shifting market conditions, many developers are looking for partners that can offer quicker access to capital and more adaptable loan terms. Debt funds are positioned to meet these needs, providing solutions for borrowers who might not qualify for conventional loans or require financing that traditional institutions cannot readily offer.
Specialized Loan Products: A Key Differentiator
Debt funds excel in underwriting loans for complex opportunities. Their in-depth understanding and product type specialization allow them to assess risks with precision and structure financing solutions that address the unique challenges each transaction presents, expanding the financing options available to borrowers. Their ability to identify opportunities that others might overlook is especially valuable.
One of the most significant contributions of debt funds is their ability to pivot in response to dynamic circumstances. Construction financing, for example, often faces challenges such as cost overruns or permitting delays. Debt funds are frequently managed by individuals with current or prior ownership experience who are deeply knowledgeable and equipped to adapt loan terms in response to these uncertainties. This responsiveness is critical in keeping developments on track. By tailoring their approach to each borrower’s specific situation, debt funds help manage risk and maintain project momentum.
Bridge loans are another area where debt funds shine. These short-term loans provide liquidity to borrowers transitioning between project phases, such as acquiring a noncash-flowing property and securing tenants, and then positioning the property for long-term financing. Debt funds are particularly well suited for this type of lending, ensuring that viable projects are properly capitalized and have sufficient runway to accomplish their business plans. The ability to underwrite these transitional loans quickly and efficiently is a competitive advantage with which other lenders frequently struggle.
Drawbacks of Debt Funds
Despite their flexibility and specialization, debt funds also have several drawbacks, such as higher interest rates or fees, because they typically provide financing for higher-risk projects. Additionally, the capital in debt funds can be more difficult to access compared to bank loans, as debt funds often require a more complex approval process and may be more selective about the projects they finance.
Debt funds are best suited for borrowers involved in complex, transitional or high-risk projects that may not align with the risk appetite of traditional lenders. However, for more straightforward or less risky projects, traditional lenders may provide more favorable terms. Borrowers should carefully assess the project’s risk profile and their own financial stability before seeking out debt fund financing.
To overcome some of these obstacles, debt funds may work alongside traditional lenders, allowing the latter to engage in more specialized projects. Debt funds provide in-depth sector expertise that complements the knowledge of their partners. This collaboration allows credit unions and banks to extend credit to projects that align with their strategic objectives while relying on debt funds to navigate the complexities of these transactions.
How Debt Funds and Traditional Lenders Collaborate
A unique advantage of debt funds is their ability to act not only as lenders but also as property owners and operators. This dual role provides significant value, particularly in distressed situations where other investors may be hesitant to step in. If a loan defaults or a project faces unforeseen challenges, debt funds can leverage their operational expertise to take control of the asset, mitigate risk and work toward recovery.
For traditional lenders, partnering with debt funds that possess operational expertise offers an added layer of security. Knowing that these partners can manage distressed assets if issues arise allows traditional lenders to pursue projects that they might not otherwise. This dual-role capability allows debt funds to gain access to more significant projects, while traditional lenders can extend their lending portfolios with greater confidence.
Both credit unions and banks bring significant advantages to the table, including expansive balance sheets, competitive pricing and access to diverse sources of capital. Debt funds, on the other hand, contribute specialized knowledge, agility and a willingness to engage in complex transactions. When these strengths are combined, the result is an integrated financing solution that supports the CRE market’s growing sophistication. This synergy also enhances the overall efficiency of the CRE financing market, allowing both traditional lenders and debt funds to capitalize on opportunities that might otherwise go untapped.
Adapting to Market Shifts
Looking ahead, the partnership between traditional lenders and debt funds is poised to strengthen as market dynamics continue to evolve. Rising interest rates and changing regulatory environments present challenges, but they also create opportunities for innovative solutions. Debt funds are positioned to adapt to these shifts, offering flexibility that complements the strategic goals of traditional lenders.
The influx of capital into debt funds further demonstrates their appeal. Investors are increasingly attracted to the risk-adjusted returns that debt funds offer, and innovations in the capital markets are helping these funds access new sources of capital.
Despite operating outside traditional oversight, debt funds have shown a commitment to maintaining credibility with institutional investors and their regulated credit union and bank partners. Their alignment with regulated entities ensures a level of discipline in their operations that supports sustainable growth. This adherence to regulatory standards is critical for the long-term success of debt funds and for promising that their offerings will remain attractive to both investors and borrowers.
The collaboration between traditional lenders and debt funds represents a powerful alliance in CRE financing. By combining banks’ stability and scale with debt funds’ specialization and flexibility, these entities can deliver innovative solutions that drive success for borrowers and investors alike. This partnership is more than a response to market needs; it is a forward-thinking model that addresses the complexities of modern CRE projects.
Charles Krawitz is executive vice president and chief capital markets officer at Alliant Credit Union.
