Why LP Equity Partners Are Hiding From The CRE Capital Stack
As a world of investment opportunities have opened up to institutional investors, limited partners have slunk away from the capital stack for commercial real estate deals.
The passive investors, typically looking for guaranteed yield, have been slow to return as market volatility has rocked commercial real estate. But that hasn’t stopped projects from moving forward, even if it means developers are taking on a different capital structure, several lenders, brokers and asset managers said Tuesday at Bisnow’s National Commercial Real Estate Finance Conference in Manhattan.
“A lot of institutional capital that had been traditionally investing as common [joint venture] LP equity has shifted and has been focused on more of a real estate debt-oriented strategy,” Greystone Capital Advisors President Drew Fletcher said during the event.
“That's made it a little bit easier for sponsors to bite the bullet and accept that they're in a much more levered capital structure, but one that gives them a greater degree of control and, hopefully, allows them to get the project moving and hope for a better day.”
In the years leading up to the pandemic, pension funds, institutional accounts and high net worth individuals were increasingly directly investing in real estate as LPs. Allocations nearly doubled from 5% in 2005 to 9% in 2017 as investors sought predictable returns, higher yields and a hedge against inflation, according to a report by McKinsey.
Then real estate values were shaken and transaction activity froze after the onset of the pandemic. Elevated interest rates and extend-and-pretend habits further prevented what was expected to be an eruption in foreclosures and dealmaking.
While commercial real estate transactions have remained muted, the stock market has reached record highs and private equity activity across sectors has surged, drawing institutional investors to a variety of places.
“There is a lot of uncertainty, obviously, and the capital-raising environment is very, very difficult,” Ron Dalal, a partner at Declaration Partners, said at the event, held at Convene 360 Madison Ave.
“These investors are not only allocated to real estate, but rather, they can go into public equities, they can go into fixed income, they can go into hedge funds.”
Private credit in particular has been among the strongest-performing asset classes in the private markets, with investors seeing it as a way to achieve equity-like returns during times of high interest rates and inflation, while assuming less risk.
In a survey of 200 LPs and financial advisers by Adams Street, 27% ranked private credit and debt as the area where they see the greatest opportunity.
Private debt funds targeting commercial real estate assets in North America have raised over $20B so far in 2025, according to a report by Cushman & Wakefield. This year is on track to become the second strongest on record for such vehicles, behind 2021.
That adds to an existing treasure trove. In 2023, private debt institutional funds’ assets under management exceeded $1.6T, including $520B in dry powder yet to be deployed, according to the Adams Street report. A decade prior, total AUM was below $600B.
The changes come as lines are being blurred across investor types, especially as there is more consolidation in the industry commanded by asset management giants. Among those are life insurance companies and private credit firms, historically two separate sources of capital, that have increasingly merged.
“A lot of the institutional LP common equity providers are just moving their role to somewhere else in the capital stack,” Naftali Group Chief Investment Office David Hochfelder said. “The ratio of debt to equity is higher, but the deals generally still get done.”
Still, some speakers said that the market has become more “LP-curious,” with the expectation that capital will start flowing again next year.
That is, in part, because commercial real estate activity has picked up. Investment volume increased 13% year-over-year to nearly $97B in the second quarter, according to CBRE. Despite volatility causing lending activity to drop this year, financing amounts rose 40% year-over-year in the second quarter.
After losing market share to banks earlier this year, alternative lenders accounted for the most loan closings in the second quarter with 34%, according to the report. Debt funds drove the increase with an 89% quarter-over-quarter and 52% year-over-year jump.
Even if LP equity investors aren’t participating in the action, it gives those investors the data points to compare future deals to.
“The more promising thing that we're seeing from an LP equity perspective is where the puck is going,” DIA Capital Group founding partner Anthony Ledesma said.
Transactions will also unlock the liquidity needed for LPs to reinvest — and they have already begun getting out of existing commitments. Two out of five survey respondents told Adams Street they planned to sell assets into the secondary market.
Secondary market transaction volume increased 45% in 2024 over the prior year to a record $162B, surpassing $132B in 2021, according to the Adams Street report.
“There are billions and billions of dollars locked up right now in legacy office portfolios and those institutions will sell those offices,” Avison Young Principal and Executive Managing Director Marion Jones said. “They will sell them, in many cases at a significant discount to their own basis, and they will redeploy that capital, often into LP or equity positions.”
Though some believe that institutional pullback from the LP side of the capital stack is part of the permanent changes in the financing ecosystem spurred by Covid, others say those investors are bound to return.
“The world is tough, but we've been through these cycles before. We're competing against the stock market, we're competing against other alternatives,” Wharton Equity Partners Chairman and President Peter Lewis said. “But long term, the guys who have their money in the market when the market collapses are going to run to real estate.”
