Debt funds can't fix the market's mess - CAERUS CEO

Private debt may have become the most dynamic corner of Germany's capital stack, but anyone hoping it will rescue the market from the valuation shock of the past three years is, in Michael Morgenroth's view, deluding themselves.

Speaking in Frankfurt during this year's Real Estate Finance Day, the CAERUS Debt Investments CEO delivered one of the bluntest assessments of where the industry stands and why the real recovery is still years away.

Morgenroth's position carries weight. CAERUS Debt Investments was one of Germany's earliest dedicated real estate debt platforms, and he has watched the market evolve from niche to necessity. His message to investors was clear: private debt is here to stay, but it remains a tool, not a cure. The discussion, moderated by Andre Eberhard of Immobilienmanager Magazin, took the form of provocative theses posed to Morgenroth, a format that produced unusually candid responses.

According to Morgenroth, the consolidation of debt funds into the real estate ecosystem is now complete. “Debt funds have definitely established themselves as a first-class option,” he said. In today's environment, lending rather than owning is the more rational way to invest. “Right now it is certainly a smarter way to invest in real estate than via equity.”

More players are entering the market, and he does not see this as a threat. “The pool is big enough for everyone,” he noted. But the resurgence of debt structures is less a triumph of innovation than the consequence of a deeper shift: the end of the zero-interest-rate illusion.

In his words, “The capital that flowed into the market in the low-rate phase is never coming back.” The misallocation was severe, and many German institutions are still “sitting on quotas they would prefer to reduce”, yet cannot, because without functioning transaction markets there is no way out.

The frozen allocation problem and refinancing reality

Several of Morgenroth's sharpest points centred on German institutions' over-exposure to real assets during the low-rate era. The hunt for yield led to questionable mezzanine products, misunderstood risks and record-high LTV structures. “Many investors invested in products whose risks they did not understand,” he said, pointing to mezzanine tranches at 95% LTV: “That was simply not risk-adequate.”

The consequences linger. “The bulk of investors won't be returning before at least 2027,” he warned. Heavy allocations, locked funds and a shortage of exits will keep German capital sidelined for years. Much of the next transaction wave, he argued, will take place “without Germans”.

The bottleneck is not liquidity. “Capital is available, but only at other terms and conditions.” The hurdle is pricing. Higher refinancing costs mean sellers must accept the new reality. Morgenroth identified two potential catalysts: regulatory pressure such as the much-discussed PL backstop, or price adjustments severe enough to clear the market. “At some point the pressure will be released. Then a price will be accepted that matches the demand for capital.”

Germany's looming refinancing wave, estimated at €35bn annually until 2030, is often cited as a sweet spot for private debt. He disagrees with that optimism. Yes, debt funds will play a role, but not as market saviours. “Extending private debt will not compensate the losses now embedded in the market,” he said. “This will not be compensated by equity either. It has to be cut off.”

The industry, he suggested, is only halfway through the valuation reset. While he sees early signs of stabilisation, he considers them fragile: “The price follows the interest curve.” And with Europe's strained public finances, he sees “few arguments for further falling interest rates”.

Back-leveraging, the return of fund-level debt or senior-on-senior structures, is reappearing in parts of the market. It may provide headline returns, but Morgenroth was unequivocal about its dangers. “Back-leveraging is nothing more than mezzanine through the back door.” Some international investors may still pursue it for return reasons; anyone aiming at portfolio stabilisation, he said, should avoid it.

Capital follows comfort, not opportunity

Asked why foreign capital often sees more potential in Southern Europe than German institutions do, Morgenroth did not hesitate. “German investors are risk-averse. Capital follows comfort zones, not opportunities.” He argued this has been true for decades. The irony is that German investors continue to over-finance their home market even when opportunity lies elsewhere.

On the question of whether private debt and banks are competitors or complements, Morgenroth was clear. Banks remain extremely competitive in the 0–60% loan-to-value range. Debt funds fill the gap for higher leverage positions where borrowers accept higher refinancing costs and risks. “The market is big enough,” he said. The two operate in different parts of the capital structure rather than directly competing.

He also dismissed the notion that private debt represents a regulatory loophole. While oversight differs from bank regulation, he sees tightening ahead. “The regulator will enforce bank-type rules,” particularly around reporting. The idea of a “shadow banking” threat, he implied, is overstated.

When asked whether private debt suffers from transparency issues, Morgenroth broadened the critique. “Which part of this industry is really transparent?” he asked. “We all live in our bubbles.” Better communication between the professions, from architects and developers to facility managers and financiers, is in his view the only path to improved clarity.

CAERUS Debt Investments itself expects further growth, “probably more outside Germany”, helped by its cooperation with Finnish private markets manager CapMan. For the German market, however, Morgenroth was not expecting a dramatic shift. “I haven't seen much change,” he said. Some transactions may return in 2026, but investor behaviour will remain subdued for longer.

His closing wish for the industry was modest but pointed: “I would like to see more optimism in the German market.” The “casinos”, as he put it, have already been pushed out of the market. Professionalism has improved. What is missing now is confidence.

For institutional readers, Morgenroth's message underscored three realities. First, refinancing risk is manageable, but only at reset prices; capital is abundant, but expensive. Second, domestic institutions remain trapped in long-term allocations, leaving space for non-German investors to dominate early-cycle opportunities. Third, debt funds will continue to expand, but prudence, not leverage, will define the winners.

The recovery will come. But, as Morgenroth made clear, not yet, and not before the market finishes absorbing the consequences of its own excesses.