Commercial real estate debt

Understanding how CRE debt investments may generate income and diversify portfolios

Commercial real estate debt

Understanding how CRE debt investments may generate income and diversify portfolios

Significant opportunity

The U.S. commercial real estate market represents a large investment opportunity with $5.8 trillion outstanding across property types and geographies.¹


U.S. commercial real estate debt market¹

An income-driven asset class

Income has been the primary driver of returns for commercial real estate debt with modest credit losses—even during the depths of the Great Financial Crisis. Credit losses occur when a lender does not receive the full amount of interest and principal due. Income has more than offset credit losses since 2007, resulting in positive net returns each year for the asset class.

CRE debt performance: Income vs. credit loss

Stacked bar chart looking at the percent of income, credit losses, and net returns over time.

Source: FS Investments, Giliberto-Levy Commercial Mortgage Index. As of December 31, 2022. Income represents the portion of the Index’s total return driven solely by the interest paid on the underlying commercial mortgages during the period. Credit losses represent the loss of principal realized during the period expressed as a percentage of the total principal value of the underlying commercial mortgages. The net income return represents the Index’s income return less credit losses for each period and can be used to understand the historical level of loss experienced by the Index compared to the level of income. Index returns are for illustrative purposes only and do not represent actual Fund performance. Index returns do not reflect management fees, transaction costs, or expenses. Indexes are unmanaged, and one cannot invest directly in an index. Although senior loans may be prioritized in payment, as represented in the image, there is no assurance that the valuation of the property that is collateral will be correct, thus, there is risk in investing in senior secured loans. They may be subject to default risk.

Investing at the top of the capital structure

Investors in commercial real estate debt serve as lenders to property owners who borrow money to purchase, renovate or repurpose a property. CRE debt investors are entitled to receive the income a property generates ahead of the property owner. This priority of payment may help protect CRE debt investor’s income and principal, especially during market downturns.

Diagram describing the order in which commercial real estate investors are paid.

What it means to be a senior lender

Being senior in a property’s capital structure is especially important when there are changes in the amount of income a property generates or property values.

After a property’s operating expenses are paid (i.e., taxes, insurance, maintenance), commercial real estate debt investors are the next to be paid from rental income. Excess income then flows to the property owner.

As illustrated in the example below, if the property value declines 15%, the CRE debt investor is not impacted while the property owner’s equity value is cut in half.

Senior lenders are better positioned vs. equity investors if property income declines

Diagram describing how a CRE investment's equity value declines before the mortgage value declines.

Let’s now look at how a decline in rental income may impact CRE debt investors. A 15% decline in annual rental income would have no impact on a CRE debt investor, while the income paid to the property owner or an equity investor would decline significantly.

Senior lenders are better positioned vs. equity investors if property income declines

Diagram describing how a CRE  equity investor's income declines before the mortgage value declines.

Investor considerations

Investors should consider key risks of investing in commercial real estate debt. Commercial mortgage loans are typically illiquid and do not have an active secondary market. In addition, while commercial loans are typically secured by a first-priority mortgage on commercial real estate properties, they are still subject to the risk of default by the borrower. There is no assurance that commercial real estate investments will provide regular, stable distributions.

More on CRE debt

Read timely updates on the commercial real estate market from our investment research team.

  • U.S. Federal Reserve, as of June 30, 2023. Commercial mortgage loans are illiquid and may not have a secondary market. Consider the key risks before investing. While commercial loans are secured by a first-priority mortgage, they are subject to the risk of default.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.


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