Commercial property distress emerging in mezzanine debt

The rise of private debt funds since the global financial crisis has reshaped how distress emerges in the commercial property cycle, with opportunities likely to be found within mezzanine structures, according to MSCI.

Following the 2008 crisis, private credit lenders replaced banks as marginal lenders, a shift that has altered how financial stress manifests in the property market, the US index provider said.

In the aftermath of the global financial crisis, distressed sales accounted for around 20 per cent of all transactions. By contrast, in the current cycle, even after sharp interest rate rises, distressed sales have reached only about three per cent of market share, according to the research.

Rather than appearing through asset sales, distress is increasingly being absorbed within private real estate debt funds, with MSCI noting that the most compelling distress opportunities are likely to emerge within mezzanine debt positions rather than direct property equity.

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MSCI added that recent performance among mezzanine-focused debt funds shows consistent declines in capital returns.

From 2015 to 2019, around 48 per cent of total returns in mezzanine debt funds were driven by income. From 2020 to 2025, however, income accounted for 210 per cent of returns, given the loan losses experienced in this riskier portion of the capital stack.

“Mezzanine lenders, through their interests in the limited liability companies that control a property, gain meaningful control rights upon default, allowing them to influence outcomes more directly,” the analysis said. “For investors seeking distressed opportunities, these mezzanine positions may be a primary point of entry into impaired assets.”

Read more: Market volatility creates distressed debt 

MSCI also said some borrowers have been willing to take on additional debt to delay foreclosure. Rather than accept immediate losses, they add a new layer to the capital stack in the hope that future price appreciation restores value.

“If the effort fails, the outcome is no worse than foreclosure; in the meantime, the mezzanine financing provides time, fees and a chance, however slim, of recovery,” MSCI said.

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