Real Estate Debt Fund Investing 101 

Experienced private market investors are likely familiar with real estate debt funds. They’ve long been a staple of commercial real estate. But for those newer to the space, these investments can feel less familiar — and less intuitive — than traditional equity deals.

Instead of taking an equity stake in a property or portfolio, investors in a debt fund act as lenders. They provide capital to real estate sponsors in exchange for interest payments.

Debt and equity investments differ in structure, risk, and how returns are generated. That’s one of the ways  debt can play an important role in portfolios: it may help diversify the risks and opportunities investors are exposed to — and how and when they get paid.* 

Let’s take a closer look. 

What Are Real Estate Direct Lending Funds? 

First, the technical definition: 

Real estate direct lending funds are pools of private equity-backed capital whose mandate is to originate senior real estate collateralized loans for qualified borrowers.

Let’s break that down, piece by piece:

• Private Equity-Backed Capital: This means the fund manager has anchor investors from the private equity world — firms that typically do diligence before committing capital and generally expect tight underwriting and reporting standards. Their involvement can potentially signal a more structured, professional-grade investment.

• Mandates: Funds are organized around a strategy for how to deploy capital and aim to generate returns. Real estate direct lending funds generally aim to make loans to real estate borrowers and earn interest in return. More specifically, a fund might focus on a narrow investment thesis — like residential construction loans for single-family homebuilders in the Pacific Northwest, secured by first deeds of trust.

• Senior Real Estate Collateralized Loans: This means the loans are backed by real estate. If the borrower doesn’t repay, the fund can take ownership of certain assets. And because the loans are “senior,” they’re first in line to be repaid — generally above other lenders or equity investors.

• Qualified Borrowers: These are developers or property owners who meet the fund’s standards — often with a track record, meaningful assets, and a generally well-vetted plan. Borrowers go through a diligence process to assess their ability to repay.

In short, a real estate direct lending fund is a pool of private investor capital designed to make secured loans to experienced real estate operators, with the goal of generating returns through interest payments.

How Can Direct Lending Funds Make Money? 

These funds make money primarily through the interest they charge borrowers over the life of a loan. But that’s not necessarily the only source of income. 

They often collect additional fees, including origination fees (when the loan is issued), extension fees (if the borrower needs more time), early termination fees, and exit fees (at payoff). 

Investors generally share in both the interest payments and those fees as part of their return on capital. For tax purposes, those returns are usually treated as ordinary income distributions.** 

What Are the Opportunities of Real Estate Direct Lending Funds? 

Real estate direct lending can potentially offer a few compelling opportunities for investors. 

First, they’re built for income. Because borrowers often pay higher rates for flexible, non-bank financing, these funds can generate relatively consistent returns compared to equity CRE investments through interest payments and loan-related fees.

They may also come with some downside protection. These loans are typically senior and secured by real estate, meaning the fund has a claim on the property if a borrower defaults. That potentially helps limit losses in a downturn, although it does not eliminate the risk of loss, including total loss, of the investment.

Perhaps most importantly, balancing a portfolio with debt can potentially diversify risk and reduce volatility. Returns come from interest payments and fees, not price appreciation — so performance is potentially steadier during periods of market uncertainty. Including debt in a portfolio adds  different features that can complement equity positions.

What Are the Risks of Real Estate Direct Lending Funds? 

Much like any investment, real estate debt funds carry risk. 

Because these are private capital vehicles — not regulated like banks — they have more flexibility in how they structure and issue loans. That freedom can be a strength, but it also places more responsibility on the fund manager to manage risk thoughtfully.

Additionally, defaults do happen, even in strong markets. During the financial crisis, real estate loan default rates peaked at 10.02% in Q1 2010, according to the Federal Reserve. By Q4 2015, they had fallen back to 3.27%. The key for fund managers is scale and diversification: the larger and more diverse the loan pool, generally the more consistent the performance—and the better positioned the fund is to price risk into each deal.

It’s also worth noting that real estate debt funds are typically illiquid investments. Unlike publicly traded bonds or stocks, investors can’t easily sell their stake or access their capital before the end of the fund’s term. These funds often have multi-year lockups, meaning your money is committed for the duration of the investment. That lack of liquidity is an important consideration — and a key reason why these funds are best suited for long-term, income-oriented investors.

Some funds offer limited liquidity on specific terms, such as periodic redemption windows or early withdrawals with penalties—features that some investors may actively seek out. But in general, liquidity remains a well-understood risk in private market investments.

How Can Debt Funds Fit Into a Diversified Portfolio?

As uncertainty hangs over both public and private markets, many analysts are encouraging investors to diversify. Spreading capital across a mix of asset classes and strategies, they say, can potentially help reduce exposure to concentrated risks.

While no strategy, including debt financing, is without risk, real estate debt funds can offer a way to diversify where your risk sits in the capital stack.

For more primers on alternative assets like real estate debt funds, visit CrowdStreet’s Investor Resource Center. And to see if you qualify as an investor in private markets, check out CrowdStreet's guide to accreditation requirements in 2025. 

*Distributions are never guaranteed.
** Tax aspects of such investments can be complex and may differ depending on the property or offering and on individual tax circumstances. Neither CrowdStreet or its affiliates offer tax or legal advice. Investors are strongly encouraged to seek advice from qualified tax professionals and/or legal experts regarding the tax consequences based on their particular circumstances.
***Diversification does not guarantee investment returns and does not eliminate the risk of loss. All investors should consider their individual factors and portfolio needs in consultation with a professional advisor of their choosing when deciding if an investment is appropriate.