Life insurance companies have maintained a steady appetite for commercial real estate debt over the past several years. And some see recent interest rate volatility as an opportunity to edge out the competition.
A few life companies have tapped the brakes on lending amid interest rate volatility and are waiting for things to smooth out, but the majority remain active participants, notes Jeffrey Erxleben, executive vice president/regional managing director at NorthMarq Capital, a commercial real estate debt and equity provider. “A lot of life companies view some of the volatility in the market today as a good opportunity to pick up good commercial loans that are out there. So, we see them being pretty aggressive,” says Erxleben.
Interest rate volatility has given life companies an opportunity to distinguish themselves compared to other capital sources. Notably, life companies are being aggressive on rates, with some lenders offering rates as low as 3 percent. They have also added different options to create value for borrowers, such as pre-payment flexibility, notes Erxleben. Life company lenders bring certainty of close, along with an ability to rate-lock early so there is less interest rate risk for the borrower.
“I think that volatility can work to our advantage sometimes because of our ability to execute quickly for strong relationships,” adds Christine Haskins, chief investment officer at PGIM Real Estate Finance. Specific to its general account lending, PGIM Real Estate Finance provides both long-term fixed and floating rate debt across the risk spectrum, from core first mortgage loans to higher yielding bridge loans. PGIM is actively looking to do deals in all property types. “We have a big focus on senior living, but that has been a little more challenging, because the agencies are very competitive there,” says Haskins.
Looking for a competitive edge
Globally, life insurance companies have remained disciplined and balance sheets remain in good shape. Commercial real estate loans continue to be a solid performer for lenders across the board, with net losses and delinquencies that are practically nil. Life companies are reporting an average delinquency rate on loans more than 30 days past due at a scant 0.002 percent, according to preliminary results released last week from the CRE Finance Council (CREFC) & Trepp Insurance Company Investment Performance Survey for the second half of 2018.
One of the biggest challenges life companies face is battling competition to place capital. “We have struggled with the amount of liquidity that is coming in from all sides,” notes Haskins. Banks that have typically stayed short with floating-rate loans are now offering longer term seven- and 10-year fixed-rate loans. In addition, life company lenders that are selectively going up higher in the capital stack to do mezzanine or bridge loans in order to generate higher yields are bumping up against debt funds and others that have crowded into the space.
Despite the long running cycle and recent volatility in interest rates, there continues to be good liquidity and appetite for commercial real estate debt across a myriad of sources. Over the past 12-18 months, everyone seems to be “fishing in one another’s ponds” in order to capture new business, adds Gary Otten, head of real estate debt strategies, MetLife Investment Management.
Life company lenders tend to focus on relatively safe core commercial real estate mortgages. Where they are dipping a toe into new waters is on the margin, such as being willing to stretch a bit on loan-to-values rations (LTVs) to win deals, notes Otten. Given the competitive rate environment on fixed and floating rate mortgages, many life companies also have alternative investment programs where they are investing in mezzanine debt, preferred equity or JV equity, as well as some construction to permanent loans, to balance out their exposure and create higher blended yields for commercial real estate investments.
Steady appetite for CRE
New data shows that life companies are keeping their foot on the gas in terms of providing commercial real estate debt financing. Commercial mortgage holdings ticked slightly higher—by 34 basis points—to reach 12.06 percent of total invested assets, according to the CREFC & Trepp Survey. The report surveys the performance of commercial mortgage investments across 23 insurance companies with a combined $226 billion in loan exposure. However, allocations span a broad range from a high of 18.5 percent to 5.2 percent.
“We find commercial mortgages very attractive and a core piece of the investment portfolio,” says Otten. MetLife Investment Management generally stays in a range of between 11 and 12 percent invested in commercial mortgages in its general account assets under management. Its loans are split roughly 50-50 between longer term fixed-rate and shorter floating rate debt products.
“What seems to be in favor for all lenders these days seems to be industrial,” says Otten. That is due to growth of e-commerce and demand for warehouse and fulfillment space. On the opposite end of the spectrum is retail, which is getting scrutinized more carefully. “We still have a reasonably favorable outlook for the right retail. We are not running away from it by any means, but it has to be very targeted and specific in terms of sponsor, location and retailer quality,” he says.
“Multifamily and industrial are clearly the favored product types out there, but we have seen renewed interest in office,” says Erxleben. Agency spreads that have widened recently have created an opportunity for life company lenders to grab more multifamily deals. Some life companies are also willing to finance well-located big-box retail. However, retail deals with top assets and borrowers are attracting a lot of lender attention.
Lenders are also keeping an eye out for pockets of potential over-building in specific markets or property types. However, development during this current cycle seems to be much more in check as compared to previous cycles, notes Otten. That is partly due to higher construction costs, as well as banks that are less aggressive on construction lending, he adds.