For real estate investors, debt markets have become a significant focus in recent years. Since 2020, $137.2 billion has been raised for debt strategies across more than 430 closed-end funds. This accounts for around 16% of CRE fundraising, a sign of investment managers’ and investors’ expanding view of real estate opportunities.

The growth in debt vehicles highlights investors’ efforts to expand capital deployment across multiple strategies, deepening offerings across the capital stack. A multitude of investment managers and investors are looking to credit strategies as a growth driver for capital deployment, and to grow their assets under management (AUM).

It's timely as well. Credit strategies can perform particularly well during elevated interest rate environments when it comes to absolute yield. To look into the diversification benefits that debt strategies offer, we evaluated the spread between capitalization rates for commercial real estate and the all-in commercial lending rate in the US relative to the 10-year Treasury.

Since the onset of the Federal Reserve’s interest rate tightening cycle in the first half of 2022, credit strategies’ absolute yield has outperformed by 15 basis points. This compares to equity strategies’ yield outperforming by 220 basis points on average during much of the past cycle when interest rates were lower, speaking to the relative favourability of credit strategies.

Lending activity during the past decade was notably more balanced and diversified compared to the period leading up to the GFC, where CMBS loan origination volume totalled 54% of originations. Debt funds, insurance companies — and, in the US, government agencies — have all accounted for a greater share of loan origination than CMBS in recent years.

And the average loan-to-value ratio of loans originated in the US since 2020 is 55%, a full 14 percentage points lower than the average ratio in 2007, generally indicating more conservative market behaviour. Loan-to-value ratios have ranged between 45% to 75% across larger European markets this cycle, and 40% to 60% across the larger markets in Asia Pacific.

New sources of debt are arising to complement funding options in markets and sectors where lenders are more cautious. Since the Global Financial Crisis (GFC), debt funds added significant lending capacity to the US market amid the slowdown of commercial mortgage-backed securities (CMBS) activity.