Over the last five years, the real estate industry has navigated an unprecedented cascade of disruptions. For a time, a global pandemic decimated office occupancy. Supply chain dislocations and geopolitics stalled or dramatically increased the cost of construction. The Federal Reserve's aggressive monetary loosening and then tightening upended traditional financing models. Meanwhile, regulatory winds pushed banks further from commercial real estate lending, leaving many borrowers stranded.
Amid this market dislocation, opportunity has crystallized in an unexpected corner of the market: real estate credit.
Real estate debt has become a beacon for institutional investors navigating turbulent waters. Real estate debt markets in the U.S. and Europe now total an estimated $6.7 trillion, with $4.8 trillion in the U.S., according to data from CBRE and AEW.1
"We believe real estate debt is an important component of a diversified real estate portfolio," said Bryan Donohoe, Partner and Head of U.S. Debt at Ares Real Estate. "One of the primary advantages is the potential for consistent and predictable income through contractual interest payments received on a recurring basis."
The ascent of real estate debt reflects a fundamental restructuring of commercial real estate finance. Regulatory forces have nudged traditional banks either into a different role or toward the sidelines, creating a financing vacuum that alternative lenders have filled — often securing terms far more favorable to lenders than would have been possible during the era of abundant bank capital.
In this transformed landscape, Donohoe added that “real estate debt provides an opportunity to balance return and risk, navigate market cycles, and complement traditional real estate equity strategies.”
Looking back, March 2022 marked a turning point, with the Federal Reserve's aggressive rate increases fundamentally reshaping real estate debt markets. While rising rates weighed against traditional bond portfolios, floating-rate commercial real estate loans benefited immediately as both base rates and credit spreads expanded. Further, many private loans were structured with interest rate floors, creating a significant buffer to the historically low base rates.
"The transition from a prolonged, low-rate environment to one marked by rapid rate hikes and inflation has significantly elevated the appeal of floating-rate real estate debt," Donohoe says. "As fixed income portfolios came under pressure, senior and transitional loans became resilient income-producing alternatives."
Real estate debt strategies that generated mid-single digit returns during a low-interest rate environment found themselves generating double-digit returns in today's market. This transformation was amplified by the commercial real estate refinancing cycle, with 15 to 25% of outstanding loans – roughly $2 trillion of notional - maturing annually.2 Banking regulations implemented in the aftermath of the 2008 financial crisis had already reduced traditional lenders' appetite for CRE exposure, creating persistent supply-demand imbalances that higher rates have only intensified.
Banks steadily reduced their direct real estate lending over the past decade. New rules implemented after the financial crisis require banks to set aside more money as a safety cushion for real estate loans and subject them to stricter government oversight. Many banks decided it would be easier to lend money elsewhere, or to lend through warehouse lines to private lenders as their form of participation in CRE shifted.
"Since the Global Financial Crisis, increased banking regulation and reserve requirements resulted in bank retrenchment from the real estate lending market," Donohoe said. "The retrenchment from these institutions has created clear opportunities for non-bank lenders to step in and fill the lending gap at attractive pricing and terms."
In addition to more attractive pricing, this shift has allowed alternative lenders to negotiate more favorable loan terms, including lower loan-to-value ratios and enhanced protective covenants. Further, the reset in values alongside the ability to target high quality collateral makes the opportunity even more compelling.
Construction lending exemplifies this transformation — designed to finance development from land acquisition to completion. In fact, this segment has become increasingly dominated by non-bank lenders seeking higher absolute returns, while traditional banks have reduced their appetite for development risk.3
Based on Ares’ view in this new landscape, institutional investors are increasingly observing real estate debt as occupying a unique position between the world of corporate credit and the realm of real estate equity.
"Rather than viewing real estate debt as a substitute for either corporate credit or real estate equity, many institutional investors are increasingly positioning it as a bridge between the two — combining elements of capital preservation, steady income, and real asset exposure," Donohoe said.
Compared to corporate credit, real estate debt has several differentiating factors. While yields often match those of senior secured corporate loans, real estate debt benefits from hard asset collateral with reset values rather than depending largely on corporate balance sheets.
“This provides a level of downside protection (consider replacing “downside protection” with: a type of defensive strategy) that’s fundamentally different than what is seen in the traditional, bank syndicated corporate credit market,” said Donohoe. Additionally, loans sourced through direct origination tend to be less sensitive to public market volatility than traded credit instruments.
Relative to real estate equity, debt investments offer something increasingly precious: predictability of cash flows. The cash flows arrive with clockwork regularity, the investment horizons tend to be shorter, and the senior position in the capital structure provides a cushion that equity investors often hope for.
Like real estate equity, debt strategies can be categorized across a risk spectrum, each with its own risk profile and return potential.
At one end, core strategies typically involve fixed-rate mortgages on stabilized properties, offering predictable returns over five to ten-year terms.
Core-plus strategies, meanwhile, often focus on floating-rate bridge loans that provide short-term financing for borrowers executing business plans associated with the continued lease up of a property in order to increase cash flow. "Core-plus real estate debt would include floating-rate first mortgages — sometimes referred to as 'bridge lending,’ which is favored by borrowers seeking short-to-medium term financing," Donohoe said.
At the higher end of the spectrum, value-add and opportunistic strategies may involve the light repositioning of a property, construction financing or in limited cases subordinated debt or. These investments offer higher return potential but rank below primary debt in terms of payment priority.
In today’s environment, all these strategies share one requirement: active, engaged management with a broad footprint. With property values under pressure and borrowers facing refinancing challenges, lenders must closely monitor loan performance and work proactively with borrowers to address potential issues. Success demands constant vigilance.
"Proactive asset management of legacy loans during a volatile market environment is critical in ensuring consistent income generation and successful loan payoffs," Donohoe said. “When managing legacy loans, lenders are challenged with monitoring various risks, including interest rate, valuation uncertainty, market illiquidity, asset performance, and sponsor execution.”
The art lies not just in avoiding potential problems, but in addressing them before they become crises. Successful asset management requires robust early-warning systems and experienced teams that can spot trouble on the horizon and chart a course through it. The goal is not just to avoid losses, but to optimize outcomes through active engagement with borrowers. Those with in-house special servicing capabilities possess a particular advantage — they can work hand-in-hand with borrowers to find solutions to increase overall returns.
Looking forward, several factors point toward continued growth for real estate debt as an institutional asset class. Interest rates, despite their recent volatility, are expected to remain well above the ultra-low levels of the previous decade, supporting returns for floating-rate strategies. Meanwhile, the trend toward bank retrenchment appears likely to continue, driven by regulatory requirements and capital allocation preferences.
The U.S. market currently represents the most developed opportunity, with non-bank lenders already accounting for less than 40% of commercial real estate debt origination, according to industry data4. European markets, representing $1.9 trillion of the global total5 , remain more heavily dominated by traditional banks but face similar regulatory pressures that could create opportunities for alternative lenders in the coming years.
“While the European real estate debt market remains heavily dominated by banks, mounting regulatory pressures and capital constraints could lead to a material shift over the near-term that will open the door for non-bank lenders to fill the lending gap at attractive spreads and lower LTVs,” said Donohoe.
These expanding global opportunities reinforce what many institutional investors have begun to recognize: real estate debt isn’t just another asset class — it’s a massive opportunity set, becoming an essential tool for portfolio construction.
"Over the next five years, we believe real estate debt is poised to become even more integral to investor portfolios—not just as a source of yield and principal protection, but as a dynamic and strategic allocation to enhance overall risk-adjusted returns," Donohoe said.
Expectations are evolving, too. Investors no longer simply want yield—they want exposure to diverse strategies across property types and risk levels, creating demand for managers who can navigate the full spectrum of opportunities with both broad origination capabilities and deep market expertise.
Ultimately, the success of any real estate debt strategy will depend on managers' ability to source attractive investments, structure appropriate terms, and actively manage portfolio risk. As traditional fixed income strategies grapple with persistent headwinds, real estate debt delivers both meaningful yield and downside protection— something increasingly rare in today’s tumultuous markets.
