"I made over $50,000 last year in passive income without owning any property or dealing with tenants."

Real estate debt funds allow everyday investors to profit from real estate while avoiding the responsibilities and risks of being a landlord.

You get regular income from interest payments on real estate loans while letting experienced managers handle all the work. These funds provide stable returns not directly tied to volatile property values.

In essence you are taking a different path as an investor—you are seeking income rather than capital appreciation, which is what most real estate funds target.

In this guide, you'll learn:

  • How real estate debt funds work and what types of loans they offer
  • The lower risks compared to owning physical property
  • Average historical returns to expect
  • How to invest in real estate debt funds
  • Pros and cons to weigh before investing

What are real estate debt funds?

Real estate debt funds pool money from investors to provide financing for real estate projects and ventures. The managers originate or purchase loans secured by commercial and residential properties.

Over time, as those loans are repaid with interest, the profits flow back to the fund's investors. The loans generate consistent income through regular interest payments from borrowers.

These funds offer loans for:

  • Fix and flip rehabs
  • New Construction
  • Multi-family properties
  • Commercial buildings

The loans are typically structured as:

First mortgages - These are loans secured by real property. The lender has first claim on the property if the borrower defaults. First mortgages carry lower risk for the lender because of the collateral.

Second mortgages - These are additional loans taken out on property that already has a first mortgage. Second mortgages are higher risk for the lender because first mortgages get paid first in the event of a default.

Bridge loans - These are short-term, high-interest loans that provide fast financing to borrowers. They are repaid once the borrower secures longer term financing. Bridge loans allow the lender to generate quick returns but they do have a higher default risk.

Mezzanine financing - This is debt financing that also gives the lender the right to convert the loan into equity ownership. It is subordinate to senior debt but offers the lender potential equity upside.

As an investor you can earn stable returns from the reliable cash flows of interest payments without having to own, manage, or flip properties yourself.

Real estate debt funds vs. direct ownership

Investing in real estate debt allows you to avoid many of the headaches and risks landlords face while still getting a piece of the real estate action:

No tenants - You don't have to find, manage, or evict tenants. And borrowers must keep up payments to avoid foreclosure.

No maintenance costs - Leaky roofs, busted pipes, HVAC repairs—all those expenses are the borrower's problem.

No declining property values - Your returns come from consistent interest payments and do not rely on the property appreciating in value.

Diversification - The loans are spread across multiple projects, so you avoid issues with any single development.

That all sounds good, but be aware that there are still risks involved, such as foreclosures if borrowers default. But professional underwriting and portfolio diversification can mitigate risks.

Historical returns from real estate debt

According to data analyzed by CBRE, a leading commercial real estate firm, private real estate debt has historically generated:

  • 5-8% average annual returns
  • 9-12% average returns during strong economic periods
  • Minimal losses, even during recessions
  • Higher interest rates are pushing cap rates higher in 2023

So, you can target 8-10% average returns over the long run which beats many other fixed-income investments like bonds or CDs.

Bridge loans for rehabs may produce even higher yields, from 10% to mid-teens. But, they also come with higher risks if projects run over schedule or budget.

Ultimately, real estate debt produces stable income through business cycles, unlike flippers that rely on continued rising home values.

Minimum investment amounts

Most real estate debt funds require accredited investor status, defined as either:

  • $200,000 annual income individually, $300,000 jointly, or
  • $1 million net worth, excluding primary residence

Additionally, minimum investment amounts often start around $50,000.

But some funds permit minimums as low as $500 for non-accredited investors. Those funds do come with higher fees, however.

How to evaluate real estate debt funds

Focus on these factors when comparing real estate debt funds:

Returns - Look for historical average returns of 8% or more over a full market cycle.

Fees - Management fees range from 0.5% to over 2%. Incentive/performance fees of around 20% of profits are also common for managers.

Loan Types - Mix of first mortgages, second mortgages, preferred equity. First mortgages on completed properties are the lowest risk.

Loan Terms - Do they provide short-term bridge loans or longer 1-5-year mortgages? Know the average loan maturity.

Borrower Profile - Residential? Commercial? Construction? Geographical and property type diversity helps.

Foreclosure Rate - Lower foreclosure rates indicate safer underwriting. Around 2-3% is reasonable.

Minimums - Funds open to non-accredited investors allow easier access. But may charge higher fees.

Liquidity - Interval funds offer quarterly redemptions. Private REITs may lock up investments for years.

Pros and cons of real estate debt funds

Real estate debt fund options

Here are some reputable real estate debt fund providers to consider:

Fundrise - Online real estate investing platform offering debt funds to non-accredited investors. $500 minimum investment.

CrowdStreet - Real estate crowdfunding site with debt fund offerings open to non-accredited investors. $25,000 minimums.

Broadmark Capital - Debt funds for residential and commercial loans. 5-7-year track record, $3-10 million minimums.

RiverNorth - REIT (real estate investment trust) investing in real estate credit. Open to non-accredited investors, $2,500 minimum.

Blackstone - Global private equity firm with a real estate debt fund. Requires accredited investor status.

American Homeowner Preservation - Bridge loans to rehab residential properties. $50,000 minimum investment.

LendingHome - Online lender that offers fractional investments in short-term loans. $5,000 minimum investment.

Real estate debt investments vs. REITs

Unlike investing in a traditional REIT that focuses on the performance of a portfolio of properties, real estate debt funds only focus on the lending part.

Rather than relying on appreciation and rents from a property portfolio, you will earn returns from the interest and fees paid on the debt. This can provide more stable cash flow than the fluctuating dividends of equity REITs.

Debt funds also give you diversification across many loans while minimizing the risks of individual property ownership.

If you're looking for fixed income streams with lower volatility compared to equities, real estate debt can be an attractive option.