Why Institutional Investors Are Shifting From Equity to Debt in Commercial Real Estate Finance

Written by:

Rudi Davis

Date:

16 Mar 2026

Share

Share via Facebook

Share via Linkedin

Share via X

Copy to clipboard

Large institutional investors are moving down the capital stack, favoring debt and credit strategies over equity positions. This shift is changing how commercial real estate deals are structured across the industry.

After years of funding development and value-add projects through equity, major institutional investors are now focusing on debt. John Randall, Head of National Production for Debt and Structured Finance at Colliers, says this migration is not due to a pessimistic outlook on real estate fundamentals, but rather a calculation that risk-adjusted returns in credit strategies now exceed those available in equity. As a result, there is ample liquidity for debt financing, but equity capital for LP and JV positions is scarce. Many sponsors are being forced to accept dilutive preferred equity structures or leave deals uncapitalized.

Institutional Investors Now Favor Debt Positions Over Equity in Commercial Real Estate

According to Randall, institutional investors have shifted to a safer position in the capital stack. These investors now prefer debt positions over equity, citing better risk-adjusted returns in the current environment.

“Much of the institutional equity participants have moved to a safer place in the capital stack, more of a credit strategies fund, so they’re much more comfortable taking a debt position in an asset versus an equity position, because the risk-adjusted returns in the credit stack outweigh those in the equity space,” Randall says.

This is not a temporary response to market volatility. Institutional capital is being systematically redirected from traditional equity to debt instruments, with no indication that investors are waiting for equity returns to improve. The practical result is a gap in the capital stack. The equity that once funded development, value-add, and opportunistic real estate strategies is now deployed in credit, leaving sponsors with fewer options for raising equity.

Institutional Equity Is Now Reserved for Only the Strongest Commercial Real Estate Transactions

Randall notes that institutional participation in LP and JV equity is now highly selective. Investors are willing to take equity positions only in the strongest transactions, specifically those with best-in-class assets, top markets, and clear execution plans. For sponsors with anything less, raising equity has become a major challenge.

“There is still limited participation in the LP and JV equity space, but mostly for very strong transactions that have clearly defined a market opportunity,” Randall says.

This selectivity has created a bifurcated market. Top-tier sponsors can still access equity capital, but most other deals struggle to close, not because of a lack of lender interest, but because of the equity gap. Many projects that would have been funded in past cycles are now stalled due to this shortage of institutional equity.

Sponsors Are Turning to Preferred Equity to Fill the Gap Left by Scarce Institutional Capital

With traditional LP and JV equity scarce, sponsors are increasingly turning to preferred equity to fill the gap. Randall notes that while capital is available for preferred equity, the terms are often highly dilutive. Sponsors must weigh the additional equity required to address leverage concerns against the lower returns relative to traditional equity structures.

“There’s plenty of capital available for preferred equity. But that can be highly dilutive, depending upon the overall structure and terms. So that is a challenge, coming to grips with the amount of equity that will have to come in to solve a leverage concern,” Randall says.

Preferred equity comes at a higher cost than standard equity, often including accruing returns, payment-in-kind interest, and priority distributions that reduce the sponsor’s share of profits and cash flow. Sponsors that previously targeted mid-teens or higher returns now face the reality that preferred equity will reduce their net returns, sometimes significantly.

Sponsors Are Restructuring Equity Stacks Before Approaching Lenders

Randall notes that sponsors are restructuring their equity stacks before approaching lenders, particularly when working with less patient equity partners. Many deals financed in 2020 and 2021 are now facing equity impairment due to falling valuations and higher interest rates. Sponsors are being required to inject additional capital, bring in new equity partners, or accept dilution through preferred equity to make deals viable.

“Yes, that is an item of chief concern amongst those who have less patient equity partners,” Randall says.

The challenge is most acute for sponsors who used aggressive leverage at peak valuations. As these loans mature, the equity buffer has eroded or disappeared, requiring sponsors to recapitalize or risk losing the asset. The bottleneck is not the availability of debt capital, but the lack of equity needed to support new loans at current property values.

Debt Capital Remains Readily Available Despite the Equity Shortfall

Despite the equity shortfall, Randall emphasizes that lenders remain eager to deploy capital. Debt liquidity is strong across agencies, insurance companies, debt funds, banks, private capital, and CMBS markets. The limiting factor is not the supply of debt, but the ability of sponsors to raise the required equity to meet lender leverage standards.

“There’s a significant amount of liquidity available to finance commercial real estate assets,” Randall says.

This disconnect has created a paradox. Lenders are willing to provide financing, but deals cannot close because sponsors cannot raise enough equity. As a result, purchase transaction volumes remain subdued, even as refinancing activity increases.

How Colliers Is Helping Sponsors Navigate the Equity Gap in Commercial Real Estate

Colliers has responded to these shifting dynamics by assembling specialized teams focused on LP and JV equity as well as highly structured finance transactions. Randall leads national production for all debt and structured finance in the U.S., working with both middle-market and institutional clients. The firm acts as an intermediary and, in some cases, as a direct lender through Fannie Mae and FHA programs, distributing capital across a broad spectrum of lenders.

“We have a team that focuses purely on LP and JV equity. We have a team that focuses on highly structured finance transactions where we’re solving for the entirety of the capital stack, not just perhaps a simple permanent financing solution,” Randall says.

As institutional capital continues to favor credit over equity, Colliers is positioning itself to help sponsors bridge the equity gap. The firm offers structured finance solutions, including preferred equity, mezzanine debt, and other hybrid instruments that connect senior debt and traditional equity.

What the Shift From Equity to Debt Means for Commercial Real Estate Sponsors and Investors

The move by institutional investors from equity to credit is reshaping commercial real estate finance. Sponsors who once relied on LP or JV equity to fund new projects now face a much more selective and costly equity market. Only the strongest deals attract traditional equity, while most others must accept dilutive preferred equity or alternative structures.

This environment requires sponsors to be more disciplined in underwriting and capital structuring, often bringing in new partners or additional capital to make deals work. For many sponsors, this means accepting lower returns or waiting for market conditions to improve.

The abundance of debt liquidity is not enough to drive transaction volume, as the equity gap remains the primary constraint. Industry participants should expect continued reliance on structured finance solutions as institutional capital prioritizes risk-adjusted returns and remains cautious about deploying equity in all but the most compelling opportunities.