Real estate private equity and direct lending are two distinct ways to finance property deals, and they pay investors in very different ways. Equity aims to grow net operating income and exit value, while lenders lock in coupons, fees, and enforcement rights. This guide shows how the two approaches compare on what you earn, what you control, and what can go wrong so you can choose the right tool for each deal.
What REPE and direct lending mean in practice
Real estate private equity is ownership capital invested into properties or platforms to increase net operating income and capture appreciation at exit. Direct lending is credit secured by property, including senior mortgages, mezzanine loans, construction loans, and preferred equity that behaves like subordinated debt. Equity earns through value creation and multiple on exit. Lenders earn through contracted coupon, fees, and remedies that protect recovery.
This comparison focuses on private equity ownership and bilateral or club loans placed directly into property capital stacks. It excludes public REIT common stock, CMBS conduit bonds, and unsecured corporate debt. The goal is straightforward: weigh what you earn, what you control, and what can break, then decide where each approach has the edge across risk, timing, and certainty.
For background on how these funds work end to end, see real estate private equity and its structures, strategies, fees, and returns. To understand public alternatives, compare REPE with REITs.
Who controls what: stakeholders and incentives
In REPE, general partners source, underwrite, operate, and exit assets. Limited partners fund commitments and receive preferred returns and a carried interest split. Programmatic joint ventures with developers or operators add specialized skill and a promote structure tied to performance. That alignment is powerful, but execution risk falls on the equity.
In direct lending, lenders target risk-adjusted carry through coupon, fees, and original issue discount. Borrowers want certainty of proceeds, flexibility on capital expenditures and leasing, and time to stabilize or sell. Intercreditor agreements set the rules among senior, mezzanine, and preferred lenders and define who can cure, control, and enforce. In stress, those rules decide outcomes and speed.
Structures, security, and where lenders sit
REPE funds commonly use Delaware partnerships or LLCs with Cayman feeder structures for non-U.S. and tax-exempt investors. Luxembourg SCSp, RAIF, or SIF vehicles are common in Europe. Equity sits in special purpose entities that own the property. Borrowers maintain separateness covenants and independent managers to support non-recourse financing. The setup reduces veil-piercing risk at a modest legal and admin cost.
Direct lenders often hold loans in bankruptcy-remote SPVs, finance through warehouse lines or repos, and use loan-on-loan facilities with eligibility tests and concentration limits. Property-level loans are non-recourse with bad boy carve-outs for fraud, misapplication, unauthorized transfers, and separateness breaches. Mezzanine lenders take a pledge of the equity in the property owner and can foreclose under the UCC to gain control, then negotiate with the senior under an intercreditor. This gives control without taking title, and UCC foreclosure can be relatively swift.
How cash flows through the capital stack
Equity mechanics
General partners call capital pro rata from limited partners to fund acquisitions, capital expenditures, and working capital, usually alongside third-party debt. The call-to-close timeline is often 10 to 12 weeks. Joint venture agreements set budgets, leasing parameters, capital expenditure approvals, financings, and exit mechanics. Minority partners rely on consent rights and replacement-for-cause provisions, which can introduce deadlock risk.
Distributions follow a waterfall: return of capital, a preferred return that is often 7 to 10 percent, general partner catch-up, then carry. Hurdles may be tied to internal rate of return or multiple on invested capital. The structure aligns incentives, but pacing depends on asset sales and refinancings.
Debt mechanics
Debt proceeds fund acquisitions or refinancings, capital expenditures subject to budgets and holdbacks, interest reserves, and fees. Senior collateral includes a recorded mortgage or deed of trust, assignment of leases and rents, UCC security interests, and deposit account control agreements. Mezzanine collateral is the pledged equity and related rights. Perfection errors are common and preventable with tight checklists.
Cash management priorities typically run taxes and insurance, debt service and hedging, operating expenses per budget, reserve top-ups, then permitted distributions. Springing cash controls can trigger on debt service coverage or debt yield tests or tenant rollover events, which acts as early warning and preserves cash.
Covenants cover loan to value, debt service coverage, debt yield, leasing and capital expenditures controls, transfers, separateness, reporting, and hedging. Construction adds completion guarantees, GMP standards, and funds control. Defaults lead to rate step-ups, cash sweeps, and enforcement. Single asset real estate borrowers face expedited bankruptcy timelines that require plans or interest payments to maintain the stay, which accelerates lender leverage.
To go deeper on mezz structures, see this primer on mezzanine financing in real estate. For DSCR modeling in loan underwriting, review a step-by-step on debt service coverage ratio.
Fees, yields, and the economics you keep
REPE fee stack
Fund-level management fees often run 1 to 2 percent on commitments during the investment period, then step down to invested capital or NAV. Asset management and property management fees apply at the asset level, and some mid-market strategies add acquisition or disposition fees. Carried interest typically pays after a preferred return and a general partner catch-up. Clawbacks and escrow holdbacks protect limited partners if timing slips. For career and strategy context, see how value add and opportunistic plans differ from core.
Direct lending economics
Lender return comes from cash coupon, original issue discount, and fees. Upfront origination or arrangement fees hit at closing. Exit fees and make-wholes protect against reinvestment risk. Unused line fees apply to construction or revolver-style commitments. Borrowers pay lender legal, appraisal, engineering, and title costs. Diligence is front-loaded and supports close certainty.
A simple case study: a $100 million purchase
Consider a $100 million property purchased with a $60 million senior loan at 7.5 percent and a $10 million mezzanine loan at 12 percent with 2 percent OID. Equity is $30 million. Annual senior interest is $4.5 million interest-only. Mezzanine interest is $1.2 million, and OID increases yield by roughly 200 basis points over the term.
In year one, NOI is $7.5 million with $1.0 million reserved for capital expenditures. Equity cash flow can be negative until assets stabilize, so reserves carry the plan. By year four, NOI reaches $9.0 million. A 6.0 percent exit cap implies a $150 million value. After repaying debt and 1 percent sale costs, equity receives roughly $78.5 million, a ~2.6x multiple and ~27 percent gross IRR before fees. Results are path-dependent and sensitive to execution and exit timing.
Return, risk, and control trade-offs
REPE collects returns from NOI growth, cap rate moves, and leverage. Dispersion is wider when business plans depend on re-tenanting, heavy capital expenditures, or entitlement work. Upside is meaningful, and downside includes capital impairment when NOI underperforms or exit yields widen. Equity is first loss and owns the business plan.
Direct lending aims for contracted yield with tighter dispersion when attachment points are conservative and underwriting relies on durable NOI. Upside is capped. Downside depends on collateral coverage and enforcement. Tail risk and time-to-recover vary by state, asset type, and document strength.
Control also diverges. Equity governs operations, budgets, leasing, and exit decisions. Lenders control through covenants, cash management, and consent rights. Senior lenders can sweep cash and block transfers. Mezzanine players negotiate cure and purchase rights. In stress, lender remedies often decide outcomes, especially in non-judicial foreclosure or UCC jurisdictions. If you need more income focus, see this overview of real estate private credit financing.
Accounting, tax, and regulatory basics
Equity funds generally report fair value under ASC 820 and often qualify as investment companies under ASC 946, with NAV-based reporting and audits. Consolidation under ASC 810 VIE rules depends on control. Under IFRS, funds assess consolidation under IFRS 10 and may use fair value through profit or loss, which increases valuation scrutiny.
Loan funds carry loans at amortized cost with CECL allowances under ASC 326 or elect fair value. IFRS 9 uses expected credit loss with staging. Nonaccrual policies pause interest when collectability is uncertain. Tax structures vary. Non-U.S. investors often use REIT or corporate blockers for equity to manage effectively connected income and FIRPTA. Lenders rely on the portfolio interest exemption when eligible, while OID and fees have distinct withholding rules.
U.S. managers register or rely on exemptions under the Advisers Act. AIFMD governs EU fundraising. AIFMD II adds prescriptive standards for loan-originating AIFs, including risk retention and concentration limits. KYC and AML apply, and Beneficial Ownership Information reporting expanded in 2024. State licensing may apply to nonbank lenders. Always track usury, choice-of-law, and enforceability.
Structural risks to watch
- NOI and valuation: Underwrite taxes, insurance, and tenant improvements and leasing commissions inflation. Stress exit cap rates and refinance proceeds to size a refinance gap.
- Cash control: Weak lockboxes or slow triggers invite leakage. Specify hardening mechanics and co-terminous reserve tests for faster sweeps.
- Perfection: Confirm fixture filings, leasehold mortgage steps, and assignments. Construction creates mechanic’s lien exposure. Use title endorsements and survey-backed legal descriptions.
- Intercreditor: Cure periods, purchase options, and remedy control can slow outcomes. Align notice mechanics and standstills to speed restructures.
- SPE separateness: Commingling and undocumented advances support consolidation claims. Enforce certifications and independent director requirements.
- SARE and rescue: In single asset real estate cases, plan for adequate protection and relief-from-stay motions. Document solvency, fair value, and proceeds tracing.
Quick screens you can run in minutes
Equity
- Replacement cost gap: If basis sits well above credible replacement cost without barriers to entry, pass or reprice.
- Lease roll and capex: If 25 to 35 percent of NOI rolls soon and your pipeline or reserves are thin, demand concessions or structure.
- Sponsor advantage: Require a clear edge in leasing, development, or operations that drives alpha.
- Exit routes: Confirm two viable exits within fund life, such as sale or refinance.
Debt
- LTV and debt yield: Set attachment points with liquidation values in mind, not just pro formas.
- Exit DSCR at stressed rates: Model a refinance at higher rates and wider exit caps. If proceeds do not clear the stack, require amortization or extension tests and fees.
- Sponsor liquidity: Verify cash to cover carry and overruns. Tighten controls if the platform depends on fee extraction.
- Enforcement reality: If judicial timelines and local friction slow recovery, reduce proceeds or pass.
When each path wins – and when to blend
Pick equity when the plan requires changing the asset through re-tenanting, repositioning, entitlements, or operating lift. Equity also fits roll-ups where multiple expansion is credible. Upside is high and volatility is higher.
Pick direct lending when borrowers need speed, bespoke terms, or flexibility beyond banks, and when you can secure attractive attachment points. Transitional assets with clear but uncertain timing often fit. Mezzanine and preferred equity fill capital gaps with negotiated controls short of ownership. For a barbell portfolio, blend current income from lending with selective, high-conviction equity turns.
| Scenario | Better Fit | Why |
|---|---|---|
| Rates stay higher for longer | Direct lending | Current yield cushions carry, refi screens keep downside in check. |
| Rates fall and cap rates compress | REPE | Multiple expansion boosts exit values on stabilized cash flows. |
| Local distress with slow courts | Senior with tight docs | Enforcement strength and cash control drive recovery odds and timing. |
Execution timelines and checklists
REPE deals often run 10 to 12 weeks from LOI to close. The sequence is purchase and sale agreement, diligence such as leases, estoppels, PCA and Phase I, zoning, joint venture terms, financing, budgets, and consents. Third-party and legal spend is meaningful. The main risk is what diligence uncovers.
Direct lending transactions often close in 8 to 10 weeks. The sequence is term sheet, third-party reports, underwriting, investment committee, loan documents, intercreditor, title and survey, hedging, SPE opinions, and cash management. Diligence is front-loaded. Close certainty is high if the collateral and documents clear cleanly.
2025 to 2026 outlook: what may shift
AIFMD II sets a clearer playbook for European loan funds, with risk retention, concentration, and conflict rules that will standardize origination and fund terms. U.S. BOI reporting tightens borrower KYC and tracking obligations, adding workflow and data needs. Bank capital and concentration management should keep pushing complex or transitional deals to private lenders, while top-tier stabilized assets seek lower coupons elsewhere. Selection of collateral and sponsor quality will matter more as distress works through property types unevenly. If rate volatility persists, SOFR floors and cash sweep triggers will be more valuable to lenders, and equity will place an even higher premium on capex discipline and leasing velocity.
Closeout and recordkeeping that prevents headaches
Archive deal files with a full index, version history, Q&A, user access logs, and servicing actions. Hash final packages for integrity checks. Apply clear retention schedules by document class. On vendor platforms, obtain deletion confirmations and destruction certificates after retention periods. Maintain legal holds that override deletion until lifted. The payoff is audit readiness and lower dispute risk.
Key Takeaway
Equity delivers upside from NOI growth and market multiple, with wider dispersion and first-loss exposure. Direct lending delivers contracted carry with capped upside and meaningful protection from collateral and structure. Choose the lever that matches your edge. Change the asset when you can create value, and protect the downside when you need current income and certainty.