Understanding Debt Funds: The Good, the Bad, and the Ones Worth Betting On

You’ve worked hard to build something. Maybe it’s a thriving business, maybe it’s a high-paying career. You’ve been told to invest for cash flow, appreciation, and tax benefits, so you jumped into equity deals. 

Then the market shifted. Distributions slowed. Opportunities became harder to read. Now your capital is sitting still, and you’re wondering: What’s the smartest next move? 

This is where debt funds come in (a strategy most investors overlook until they need stability, liquidity, and control). 

Take Chris, a business owner who shifted part of his portfolio into a well-structured debt fund when equity distributions paused. Within 60 days, his income resumed, giving him the freedom to act on the right opportunities without draining his reserves. 

The Missing Layer in Your Portfolio 

If you’ve gone all-in on equity, you’ve left yourself exposed in this market cycle. Equity’s great for growth, but it can’t always provide the steady cash flow that keeps you moving forward. Debt can. Think of it as the missing leg of your investment stool (balancing growth, income, and liquidity). 

What Debt Funds Are 

Debt funds pool investor capital to lend to real estate operators—most often for property purchases, but also for rehabs, construction, or other obligations. In many cases, the debt is secured by the asset itself, but not always (more on that in the risks section). 

You earn interest that is predictable and consistent, without the headaches of being a landlord. Because debt sits at the base of the capital stack, you get paid before equity holders, and that structure alone can lower your risk compared to equity. 

Why Now Is the Time to Pay Attention 

For cash flow seekers, equity deals that produce immediate income are rare right now. Growth-focused investors can still find value-add equity plays, but they often come without current distributions. Holding cash feels safe, but even inflation of 2% to 3% erodes its value. 

A well-structured debt fund keeps your capital working, producing income, and giving you liquidity options. Historically, debt strategies have helped investors preserve capital and stay liquid during market slowdowns (positioning them to act quickly when equity opportunities reemerge). 

Equity vs. Debt at a Glance 

Before you decide how much of your portfolio should be in each, it helps to see them side-by-side—the differences in risk, cash flow, liquidity, and timelines become clear fast.

Which Debt Funds Fit Your Goals?

Not all debt funds are created equal. The fit with your risk tolerance and capacity depends on four key areas: 

1. Asset type 
2. Phase of the project 
3. Position in the capital stack 
4. Structure of the investment 

The less risk you take in each area, the more conservative the fund. The more risk you take in one (or more), the higher (and potentially compounded) your overall exposure. Align your personal risk tolerance and capacity with the right mix in these four areas. 

What Can Go Wrong 

Debt doesn’t mean zero risk. Even conservative-looking funds can hide pitfalls: 

• Asset type: Concentration in volatile sectors magnifies losses. 
• Phase: Early-stage or distressed projects increase exposure. 
• Position: Junior lien or unsecured positions risk being unpaid in a default.
• Structure: Poorly designed redemption terms or lack of diversification limit exit options. 

You need to know exactly how each deal is underwritten, your lien position, who the borrowers are, and the recovery plan if something goes wrong. 

How to Vet a Debt Fund (3P Framework) 

Before you commit capital, you need a clear, repeatable way to evaluate any debt fund. The 3P framework helps you look beyond glossy marketing decks and focus on what actually protects (or puts at risk) your investment: 

1. People: Who’s raising versus deploying capital? Have they managed a debt fund before? Are they transparent, experienced, and investing alongside you? 

2. Process: How are loans sourced, underwritten, approved, and monitored? How are defaults handled and deficiencies avoided?

3. Protections: What lien position do you hold? Max LTV? Borrower guarantees or cross-collateralization? Is there a tested exit plan? 

The Good, the Bad, and the Ones Worth Betting On—Using the Underwriting Grid 

One of the best tools you can use is an underwriting grid, paired with “what to look for” benchmarks: 

Due Diligence Questions to Ask for Each Factor 

This list works hand-in-hand with the underwriting grid above—think of the grid as your scorecard and these questions as the follow-up probes that reveal the story behind each score. Before you invest, use them as a checklist to dig deeper into the fund’s structure and risk profile so you can move past surface-level marketing and understand how the deal truly operates. 

• Capital stack: What lien position will I hold, and how is it documented?
• Asset class: What sectors make up the portfolio, and how have they performed in down markets? 
• Diversification: How many loans, borrowers, and markets are represented? 
• Distribution: How often will I receive payments, and what’s the reinvestment policy? 
• Default rate: How is default calculated, and what recovery steps are in place? 
• Lockups: What’s the exact redemption process, and are there penalties? 
• Leverage: Is leverage used at the fund level, and how does it impact returns? 
• Breakeven: What occupancy or repayment rate is needed to meet obligations?

Myth Busting 

Let’s address three common misconceptions that keep investors from exploring debt funds—even when they could be a perfect fit. 

1. Myth: Debt funds are only for ultra-conservative investors. Truth: They can be structured for different risk profiles. 
2. Myth: You can’t make meaningful returns with debt. Truth: Well-structured funds often deliver 6% to 12% returns with compounding. 
3. Myth: Debt ties up your money for years. Truth: Many have 90-day redemption windows after an initial lockup. 

What About Tax Benefits? 

For many investors, this is where resistance sets in. You’re used to chasing depreciation and write-offs, so investing without them feels counterintuitive. 

Here’s the reframe: While debt funds skip the paper losses, they also skip the capital calls, surprise expenses, and operational headaches, replacing them with predictable cash flow you can redeploy into other tax-advantaged strategies, such as cost segregation-heavy multifamily, opportunity zones, or oil and gas. 

The Real Payoff and Wrap-Up 

Debt funds give you more than returns—they give you control, timing, and options. The win isn’t just monthly deposits; it’s being able to step into the right equity deal when it appears. 

Imagine checking your account each month, seeing steady deposits while your capital remains ready for the next big opportunity. No scrambling to cover shortfalls, no anxiety over market swings—just the confidence that your portfolio is working for you, giving you the freedom to choose what’s next on your terms. 

You’ve now got the tools to evaluate whether debt belongs in your strategy. 

If you’re sitting on cash or unsure where to move next, send me a private message here on PassivePockets. I’ll walk you through how to evaluate a debt fund using these frameworks and help you decide if it’s right for your goals.

About The Author

Whitney Elkins-Hutten is the Director of Investor Education at PassiveInvesting.com, founder of AshWealth.com, and author of the award-winning #1 bestselling book Money for Tomorrow: How to Build and Protect Generational Wealth, published with BiggerPockets. With a portfolio of $800M+ in real estate—including multifamily, self-storage, and car washes—she helps high-earning professionals and business owners protect, steward, and grow their wealth through tax-efficient, passive strategies. Connect with Whitney at PassiveInvestingWithWhitney.com to discover how your money can work harder for you.

Author of Money for Tomorrow: How to Build and Protect Generational Wealth published with BiggerPockets (https://ashwealth.com/book)

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