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

Written by:

Rudi Davis

Date:

16 Mar 2026

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After years of funding development and value-add projects through equity, major institutional investors are now focused on debt.

“They’re much more comfortable taking a debt position in an asset versus an equity position,” Randall says, “because the risk-adjusted returns in the credit stack outweigh those in the equity space.”

A Shrinking Pool

Raising equity has become a major challenge for most sponsors. Where institutional investors once funded development, value-add, and opportunistic strategies through limited partner and joint venture structures, that capital has largely migrated to credit. What remains in the equity market is highly selective. Investors will commit to equity positions only in the strongest transactions — best-in-class assets, top markets, clear execution plans. “There is still limited participation in the equity space, but mostly for very strong transactions that have clearly defined a market opportunity,” Randall says.

The result is a bifurcated market. Top-tier sponsors can still access equity capital, but most other deals struggle to close — not for lack of lender interest, but for lack of equity. Lenders across agencies, insurance companies, debt funds, and banks remain eager to deploy capital, but that willingness cannot compensate for an equity shortfall. Many projects that would have been funded in past cycles are now stalled, waiting either for equity partners willing to engage or for market conditions that make the math work again.

The Cost of Preferred Equity

With traditional equity scarce, sponsors are increasingly turning to preferred equity to fill the gap — but at a cost. Unlike standard equity, preferred equity typically includes accruing returns, payment-in-kind interest — meaning interest that accrues rather than gets paid in cash — and priority distributions that reduce the sponsor’s share of profits and cash flow. “There’s plenty of capital available for preferred equity,” Randall says, “but that can be highly dilutive, depending upon the overall structure and terms.”

The dilution is not a minor consideration. Sponsors who previously targeted mid-teens or higher returns now face the reality that preferred equity will significantly reduce their net returns. The more leverage concerns a deal carries, the more preferred equity it requires, and the more the sponsor’s economics erode. For many, the calculation becomes whether closing a deal on unfavorable terms is preferable to not closing it at all.

Deals Under Pressure

The equity gap is most acute for sponsors who used aggressive leverage at peak valuations. In 2020 and 2021, near-zero interest rates and rising property values made high leverage look manageable — deals underwrote to assumptions that no longer hold. Many of those loans are now maturing into a market where valuations have fallen and financing costs have risen, leaving the equity buffer that once supported them eroded or gone entirely. Sponsors are being required to inject additional capital, bring in new equity partners, or accept dilution through preferred equity to make deals viable.

“That is an item of chief concern among those who have less patient equity partners,” Randall says.

The bottleneck is not debt. Lenders remain willing to finance commercial real estate assets, but they require sponsors to meet leverage standards that the current equity market makes difficult to satisfy. The paradox is that a market flush with debt capital is nonetheless seeing subdued transaction volumes, because without equity, debt alone cannot close deals. Sponsors who cannot recapitalize risk losing the asset entirely.

The Road Ahead

The institutional shift from equity to credit is not a temporary rebalancing. As long as risk-adjusted returns favor debt, institutional capital will remain in the credit stack — and the equity gap will persist. Sponsors who built their business models around ready access to institutional equity will need to adapt, whether by accepting the economics of preferred equity, restructuring deals to attract the limited pool of traditional equity, or waiting for conditions that may not return on any predictable timeline. The commercial real estate market has plenty of capital. The question is whether sponsors can structure deals that make it usable.