In the year ahead, Northwestern Mutual would like to increase its commercial/multifamily real estate allocations. The Milwaukee, Wis.-based life insurer closed approximately $4.5 billion in commercial real estate transactions in 2011, but its aim is to raise the figure to $5 billion annually, says Dave Clark, senior vice president of real estate with Northwestern Mutual.
However, Clark doesn’t know if his group will find enough assets to satisfy the company’s stringent underwriting requirements to do an extra $500 million in mortgages this year.
The conundrum Northwestern Mutual faces is representative of the life insurance sector as a whole. Of all commercial real estate funding sources, life companies are the most conservative, offering financing to high-quality sponsors on top assets with loan-to-value ratios that rarely exceed 60 percent. They also employ stringent underwriting assumptions on rental and occupancy growth.
This parsimony paid off, as shown by the microscopic delinquency rates within life insurance portfolios compared with other lender types. But it also means it’s difficult to source deals, since the pool of assets and borrowers that life firms will consider is small.
Delinquency rates (measured as 60+ days overdue) on life insurance company books stood at just 0.19 percent at the end of the third quarter, down from a recessionary peak of 0.31 percent in the first quarter of 2010. The methodologies differ, making a straight comparison impossible, but the figure is starkly lower than delinquency rates for CMBS loans (8.92 percent) or commercial banks (3.75 percent) during the same period.
The low level of delinquencies means life insurance companies have less distressed debt on their books and, therefore, fewer problems to deal with. As a result, they can focus on initiating new business.
Life insurance companies have taken advantage of market conditions, to grow their lending volumes more aggressively than other lenders. In fact, through the third quarter of 2011, the sector already had originated more loans than in any prior full year.
Life insurance firms would like to increase that volume even further in 2012—but not at the expense of what’s made them so successful so far.
“We plan to increase commercial mortgage lending for at least a third straight year in 2012, continuing to fill a void left by the banks that have pulled back and a real estate securitization market whose recovery has come only in fits and starts,” says Robert Merck, senior managing director and head of real estate investments with MetLife. “We, and most other life insurance companies, benefited tremendously from our low-risk investment strategy during the downturn. I see no reason for a change now.”
What to do
In Northwestern’s case, in 2011 just under 40 percent of the real estate lending the firm completed was on regional mall properties (multifamily and office buildings made up another 28 percent and 25 percent respectively).
The volume in retail was bulwarked by the fact that retail real estate owners used to tap the commercial mortgage-backed securities (CMBS) market for debt. As that business is a shell of its former self, retail owners are turning to life insurance firms instead.
Yet the retail sector also still has red flags due to concerns about the historically high level of vacancy rates and questions about the sustainability of consumer spending. As a result, Northwestern Mutual will only lend on retail assets if they feature at least one, and preferably several, anchors, and if the tenants’ sales levels justify their occupancy costs.
In November, Northwestern Mutual and Prudential Mortgage Capital Co. each provided approximately $100 million to Santa Monica, Calif.-based mall REIT Macerich for Los Cerritos Center, a 1.3 million-sq.-ft. regional mall in Cerritos, Calif. anchored by Nordstrom, Macy’s and Sears.
Similarly, MetLife provided $250 million of an eight-year, $450 million loan with the New York State Teacher Retirement System to General Growth Properties on the 1.9-million-sq.-ft. Natick Mall in Natick, Mass. But it’s hard to find deals like those every month—there are only so many regional malls owned by publicly traded REITs in need of financing.
Building steam
Life insurance companies reached record levels of commercial real estate allocations in 2011. Through the third quarter, life insurance firms had committed $34.66 billion, according to the American Council of Life Insurance Companies. Meanwhile, the average size of mortgages closed rose as well, to $20.5 million from $15.5 million a year ago, according to the Mortgage Bankers Association.
Life insurance companies will be as aggressive as they were in 2011, says Larry Stephenson, an executive vice president in commercial real estate banking firm NorthMarq’s Minneapolis office. “They were very pleased with the business they saw, the spreads they’ve been able to generate. I’ve been told the real estate sector is very attractive compared to other sectors.”
Life insurers might allocate $45 billion to $50 billion to commercial and multifamily real estate transactions in 2012, says Tom Melody, co-head and executive managing director of Jones Lang LaSalle’s real estate investment banking group.
“What they are trying to do is right-size their portfolios,” Melody says. “They don’t want to go down on the quality scale, but they are willing to decrease the rate. Leverage will be below 70 percent, pricing will be below 3 percent fixed on five-year money and 4 percent on 10-year money.”
But they won’t change their risk profiles, Melody adds. “The big ones ... will concentrate on deals $35 million and more. The smaller [ones], rather than increase their risk profile, will just do smaller deals.”
And when it comes to property types, life companies will be the most active in the retail, office and industrial sectors. Some have also begun to do hotel deals.
Life companies would also like to be more active in the multifamily space and, in fact, have upped their volume in that area in 2011. At the end of the third quarter, life insurance companies had $48.99 billion of outstanding multifamily debt on their books, up from $48.08 billion at the end of the second quarter, according to the MBA.
But competing with the agencies remains a tough play, so it will remain a smaller part of life insurance books. Overall, life companies have just 6.1 percent of the total $806.15 billion in outstanding multifamily debt, less than half the share they have for commercial real estate debt as a whole.