Real estate debt: a promising blind spot?

PENSIOEN PRO PARTNER ROUNDTABLE

Dutch pension funds are steadily expanding their private credit portfolios, yet one segment remains largely unexplored: commercial real estate debt. Despite its long history and growing relevance across Europe, the asset class rarely features in ALM studies or strategic investment discussions. This has prompted Pensioen Pro to host a roundtable centred on one question: why is real estate debt a blind spot, and should that change?

During the roundtable, specialists compare views on market conditions, ESG opportunities, regulatory hurdles, and European property dynamics. One theme emerges quickly: the European real estate market has undergone an exceptionally sharp correction, potentially creating an attractive entry point.

Values are lower from peak to trough by 30 to 50 percent, depending on the property sector; in particular, the office sector has seen the largest declines, according to Rupert Gill, Head of Portfolio Management for European Real Estate Debt at Barings. He views this price drop as one of the factors significantly altering the dynamics of commercial real estate (CRE) lending.

Gill: “I don’t know of other credit asset classes that have experienced such a dramatic change in valuations. Interest rates, construction costs, and the cost of finance have all gone up. This has led to a dramatic drop in property values. Your downside as a lender is therefore very different than five years ago.”

Other participants, however, stress that risks remain. According to Erik Prakken, Senior Portfolio Manager at Achmea Investment Management, distressed situations do not always come to the surface as some banks choose to ‘extend-and-pretend’. And while timing may appear favourable, structural hurdles still hold back wider adoption by pension funds, including the segment’s complexity, governance demands, and limited benchmarking.

Real estate debt: not on the radar

According to André van Werven, Head of Investment Management at pension fund Bpf Levensmiddelen, the asset class simply “doesn’t show up” in most ALM studies or strategic discussions. “The category is more or less a blind spot between all the regular categories like equities, investment-grade credit, and real estate.”

Bpf Levensmiddelen currently has no allocation, though Van Werven does not rule out possible future interest. “Every asset category needs to be a good diversifier relative to the rest of the portfolio. If there is low correlation with other asset classes, it could be an attractive addition.”

Gill adds: “The segment can act as a diversifier, but it also has a very distinct risk-reward profile. It is indeed still a nascent asset class, which is probably why it is not yet on the agenda of many European pension funds.”

Prakken observes that many pension funds are looking more closely at illiquid credit under the new pension scheme. “They see spread as an important factor, compared to Dutch mortgage investing.”

An earlier attempt ran into obstacles, Prakken explains. Referring to a now-closed CRE fund where he served on the exit committee, he notes that during that period, spreads were considered less attractive than those for residential mortgages, especially on a risk-adjusted basis. “The fund lacked the scale to compete with banks, so they got more of the ‘leftovers’, the secondary deals. Liquidity was also an issue.”

Complexity and illiquidity

Roy Kroon, Team Lead Credit Investments at PGB Pensioendiensten, confirms that CRE debt does not naturally appear in the ALM process. “We currently do not invest in it. An important reason is the complexity; there are many segments and approaches within real estate debt. Pension fund boards do not like complexity; they want to understand what they are investing in. However, we do have an allocation to private debt, which is increasing. Within that, impact is a relevant topic. Investments like real estate debt could be interesting from an impact perspective, energy efficiency, for example.”

Kroon also mentions illiquidity as an important hurdle. “Furthermore, the risk and return ratio does not seem particularly attractive to me. As for retail, you have to be in prime locations, while facing potential threats from the internet and web shops, as well as changing consumer preferences. Sustainability could be a theme, but currently, housing construction is not a focus theme for our fund.”

A strategic fit for pension portfolios?

For Russell Investments, CRE debt is a strategic choice, says Ruud Weerts, Senior Research Analyst, Private Markets. “The most important reason to invest in European commercial real estate debt is the diversification this asset class offers within our broader private markets allocations.”

Because CRE debt correlates only modestly with other private credit strategies and direct real estate, it strengthens the overall risk and return profile, Weerts says. He also points to attractive risk-adjusted returns and robust collateral structures.

Another advantage, he adds, is the ability to allocate capital responsibly at the local level. Weerts: “We like to work with managers who are active locally and can invest in sustainable and economically relevant real estate projects. This ties in well with our focus on sustainable value creation and responsible investing, while realising attractive return potential.”

With banks partially retreating from the lending market, the opportunity set for institutional investors has shifted dramatically, according to Gill. “A decade ago, mezzanine strategies dominated the landscape; today, institutional investors can access the entire capital stack, from senior investment-grade loans to construction finance. That whole range was not available 10 to 15 years ago.”

This diversity enables real estate investors to build fixed-income-like portfolios within their allocation, Gill continues. “And it is available in scale. You have more managers in Europe and the US, and more European-based managers now offering everything from investment-grade senior loans through to levered whole loans and mezz.”

A fragmented asset class

Prakken notes significant performance differences across segments such as multifamily, retail, and offices, which further complicate the overall picture. Another challenge, he says, is the variation between European markets. “The legal framework and political climate can be totally different. If you invest in Spain and you are a contract party as an investor, you need a fiscal number there and a transfer agent. Europe is less transparent and less comparable in data.”

Gill agrees: “Regarding property valuations, we have seen a significant fall in office values. Multifamily has recovered quickly. Logistics has recovered quickly as rents have risen. If you look across debt funds, some have been wiped out, but Senior lending strategies and whole-loan strategies have probably survived, and performance looks good.”

Gill confirms the jurisdictional challenges. “Italy and France are very difficult to lend in unless you are an EU bank. You can get capital in, but getting capital out can be difficult. We historically have not lent in Italy and France. Our equity teams find great investments there, and I think there are some very good lending opportunities; but you have to take special care with security and enforcement arrangements to be able to justify returns.”

Too much capital chasing the same deals?

Prakken questions whether markets for the best investment-grade deals are not becoming too crowded. “There seems to be a lot of dry powder in the market. According to a recent CBRE lender survey, 80% of institutional money wants to increase allocations to CRE debt. Is there enough opportunity? Consensus is that many loans will come due and need refinancing, but this seems muted in practice. Spreads have clearly tightened, roughly 25 to 50 basis points compared to last year, as more capital is chasing the same deals.”

Gill acknowledges the competition but says it is not overwhelming. “In certain parts of the market, there is much less competition. With an investment-grade deal, a debt broker might get up to 20 term sheets from willing lenders, but where we see value is in providing capital to transitional properties. That is somewhat riskier, but you can improve asset quality and ESG credentials, aiming to improve the credit rating of the loan.”

Weerts adds: “Although competition has increased in recent years, we still see room in Europe for specialised managers to structure attractive deals with favourable terms and attractive yields. We view the European market as less mature than the US market because banks still play a major role. We still see the market as less saturated, but interesting enough to gain exposure to real estate and infrastructure financing. The key is to identify the most suitable managers for each specific allocation objective, while limiting the deployment risk.”

Gill points out that performance is attractive: debt has outperformed real estate equity in the US and in Europe. “If you look at relevant equity indices over the last five years, returns will be around 2 to 2,5 percent. The debt funds we manage in Europe generated, on average, an unlevered return of mid to high single digits over that period.”

Richard Sanders, Lead Asset Manager at Lifetri Group, agrees: “Last time I looked at core real estate equity investing, I noticed that net rental yields here in the Netherlands, post-tax recurring income, are typically low, in the 1,5 to 2,5 percent range. That is lower than the coupon on loan debt. Equity investing is heavily dependent on value appreciation, taking a strong view on where it is going.”

Gill: “Indeed. Now is a better time to invest in real estate equity than five years ago. But if you are uncertain about valuations, debt provides added certainty. If values are off by 10 percent, as a lender, you still get your principal back and your return. If values are off by 25 to 30 percent, that is different, but off by 10 percent is manageable. In equity, being off by 10 percent destroys your returns.”

A growing role for transitional finance

Participants see a growing role for transitional finance within European real estate debt. Most agree that compelling opportunities are found not in fully stabilised assets but in properties requiring refurbishment, repositioning, or ESG-driven upgrades.

Gill describes this shift as structural. Banks are increasingly focusing on the safest investment-grade assets under regulatory pressure, leaving a funding gap for borrowers seeking capital to modernise ageing buildings. “You can structure a loan that fits the borrower’s business plan rather than saying: ‘My credit policy is this, and you have to stick to it.’”

He illustrates the point with a recent loan transaction in Germany. A borrower acquired a multifamily property well below replacement cost and structured a significant capex plan for upgrades. “Including fees, we are earning around a 450 basis points margin,” Gill says. “Loans on stabilised multifamily properties in Germany typically earn 100 to 150 basis points margins, or even less. The return differential reflects the added complexity of the business plan and the value created during the two to three-year transition period.”

The appeal of transitional debt

Transitional real estate debt is appealing because it allows lenders to combine higher margins with shorter loan durations, concludes Kroon. “These project-linked loans align well with pension funds’ interest in recycling capital and measurable improvements. If you invest in a building or project with a turnaround element – rebuilding, renovation, ESG improvements – it might be interesting to have a loan with the same life as the project. For the loan provider, this is interesting because you can recycle the capital into a new project.”

Kroon stresses that CRE debt should not be treated as a single bucket. Retail in particular carries specific risks. Gill agrees. “Technically, we could invest in any country or asset class within limits. But over 13 years, we have maybe made three or four retail loans. Our office exposure is similarly selective.”

Insurers face constraints in the segment, says Sanders. Senior lending is often the most capital-efficient option, so that senior debt is preferred over mezzanine debt or other subordinated structures. “We can then either stay in the investment-grade space and compete with banks, or we can do something differentiated and earn higher margins. Lifetri therefore focuses on assets with solid fundamentals that undergo some form of construction or development, or prime assets with unusual or short lease terms, such as hotels or short-stay accommodation. In both segments, you earn 400 to 600 basis points in excess of swap or cash rates, but structuring takes a very long time, sometimes six months.”

Exit options can also be limited, continues Sanders: “A project in Ireland comes to mind – everything was fine, but only two banks could take it out, and they were at capacity. No crisis, quality property, but no financing available. You then end up extending the loan. There is not much else you can do.” Illiquidity in certain property types, such as hotels, can further complicate exits. “Investing in France, for example, requires setting up special purpose vehicles tied to collateral rights, which adds a layer of complexity and costs,” Sanders says.

Hurdles for Dutch pension funds

For many pension funds, the appeal of real estate debt lies in its low correlation with mainstream fixed income and public markets. But correlations must be backed by transparent, standardised data, which the market still lacks.

A recurring issue is the asset class’s breadth. Kroon notes that boards need clarity. “The segment is broad, and pension funds need guidance to navigate it. Complexity risk has to be rewarded; otherwise, it is hard to justify.”

Participants agree that without clear segment definitions, such as senior, whole loan, transitional, or mezzanine, trustees struggle to place the asset. Sector-wide standardisation could reduce onboarding friction. Sanders adds that real estate debt lacks comprehensive, asset-owner-oriented reports. “There is no single place where all relevant information comes together.”

KYC poses another challenge. Prakken describes cases where lending directly through separate accounts became unworkable, as you need to identify the ultimate beneficial owner within the structure. Recently, we encountered a situation where a borrower had multiple layers of private limited companies linked to the loan. KYC requirements demand a complete understanding of the organization’s structure, which must be updated periodically. Such a complex setup is therefore not workable from a KYC perspective. As a result, some segregated accounts are currently on hold until a scalable process is developed.”

Prakken added that regulatory scrutiny will play an increasingly decisive role, contributing to the appeal of external managers. “We have to ensure that those managers have KYC policies that meet Dutch standards,” he said.

Transparency, or the lack of it, is another sticking point. The absence of benchmarks for European real estate debt makes it difficult to compare managers or place the asset alongside private debt, infrastructure debt, or corporate credit. Gill noted that MSCI has recently launched a real estate debt index. “But everyone does something slightly different,” he said. “That makes benchmarking difficult.”

Impact as a central factor

Looking ahead, participants highlight education and standardisation as key to making real estate debt more accessible. Van Werven argues that ESG and impact will be decisive. Pension funds under the Future Pensions Act must demonstrate real-world outcomes, which creates opportunities in transitional real estate. “Limiting CRE debt strategies to transition or impact projects could help, but only if deal flow remains sufficiently broad.”

Transparency on correlations will also help, Van Werven says. “Many pension funds are looking for diversifiers to lower the risks, so providing transparency helps inform decision-making. Under the new pension regime, there is more room for return investments, liquid but also illiquid.” Operational complexity remains a barrier. “They would welcome a manager who takes this off their hands.”

Prakken sees a strong case for impact-focused strategies. “Almost forty percent of global carbon emissions come from buildings. The expectation is that 85 percent of today’s buildings will still be standing in 2050, of which 75 percent are not energy-efficient. Hence, this asset class has quite an opportunity to help address that. We see already one third of the lenders offering margin step-downs for sustainable assets.”

Gill confirms that sustainability is increasingly embedded. “Banks and debt funds are more focused on it. Regulation has made sustainability a bigger focus. Across Europe, we see good opportunities. I do not think we are cutting returns to lend against assets with impact.” For Gill, ESG considerations are part of basic lending. “If you want liquid real estate, liquid for tenants and for eventual buyers, you need to consider ESG factors. You do not want to be sitting there at maturity with no tenants or buyers.”

Weerts adds: “Real estate private debt is one of the few areas where capital can simultaneously deliver stable income and drive measurable improvements in the built environment. By financing energy upgrades, affordable housing, and more resilient assets, we help accelerate the transition without sacrificing returns. Importantly, the availability of public guarantee schemes makes this space even more appealing for insurance investors, as these structures can significantly reduce capital charges and improve the risk–return profile.”

Conclusion

With CRE valuations now substantially lower, transitional lending can offer strong margins and fulfil impact ambitions. But investors must accept the operational and governance demands. Whether Dutch pension funds will move in remains uncertain. Still, participants agree: the combination of downside protection, stable income, and the growing relevance of transitional finance alongside impact makes real estate debt increasingly difficult to ignore.

Participants:
→ Richard Sanders
Lead Asset Manager, Investment Management – Lifetri Group
→ André van Werven
Head of Investment Management at Bpf Levensmiddelen
→ Roy Kroon
Team Lead Credit Investments – PGB Pensioendiensten
→ Ruud Weerts
Senior Research Analyst, Private Markets – Russell Investments
→ Erik Prakken
Senior Portfolio Manager – Manager Selection & Monitoring – Achmea IM
→ Rupert Gill
Head of Portfolio Management for European Real Estate Debt – Barings