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

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

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.

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

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

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.