Despite Having Available Cash, Don't Count on Life Companies To Pick Up the Lending Slack
|Credit: Detail from The Battle of Prairie Dog Creek by Ralph Heinz|
For the last couple of months now, there has been talk in the commercial real estate industry that life insurance companies were or would be stepping in to fill the financing void left by the cessation of CMBS market activity. While there are signs that life insurers are becoming more active, the talk may prove to be more wishful thinking than reality.
The commercial mortgage-backed securities (CMBS) industry overtook life insurance companies as a commercial real estate financing source in 2001. Since then, CMBS issuance increased exponentially, while the life insurers either held steady or retreated.
Then came August 2007 when capital markets froze in their tracks due to the burgeoning problems in the subprime markets and the complete aversion to real estate risk. CMBS issuance stopped almost entirely.
The constriction in capital flow has continued through the first quarter of this year and the outlook for commercial real estate has weakened due to softening tenant demand for space and the slowdown in property acquisitions. It's a classic Catch 22 situation: Without financing, leases and acquisitions are not getting done. But leases and acquisitions need to get done in order to encourage financing.
Hence, the industry has been waiting to see what life insurance companies would do, hoping that, like the calvary in an old western, they would come charging to the rescue. But it's now looking more and more like life insurers, which have plodded conservatively along during the bull market and run up of real estate property values, will continue along that same path.
This week, Teachers Insurance and Annuity Association of America has started the process of raising money for a new real estate investment fund. (See details of the fund offering at the end of this story.) However, while they might be raising more money, only a small portion of it is going to be earmarked for properties outside its core investment strategy.
The buzz in the industry is life insurers have significantly more deals to choose from than they have dollars they are willing to allocate to real estate. So they are cherry picking the very best deals.
Mark Wilsmann, managing director of Metlife Real Estate Investments in Morristown, NJ, told CoStar Advisor
that it is true enough life companies' portfolios are in good shape and they are positioned to continue lending, because they generally avoided the overly aggressive lending that occurred in 2006 and the first half of 2007. But don't take that as a sign they are here to bailout the conduit lenders.
"Annual life company lending volume has been $45 billion to $50 billion per year, versus more than $200 billion for CMBS lenders," Wilsmann said. "Because life companies maintain disciplined asset allocation/portfolio diversification, they will not increase their lending activity to make up for the loss of CMBS debt capital, despite the relatively attractive current 'lender's market.' Because life companies generally shy away from Class B and C properties, small markets, thinly capitalized borrowers, and transitional properties, they are not making up for the loss of CMBS capital in these sectors."
"Life companies generally focus their lending on Class A properties, in strong markets, with experienced, well-capitalized borrowers," Wilsmann said. "As investors, life companies are concerned with the impact of the softening economy and ongoing credit crunch on real estate cap rates and values. Because of the likelihood of rising cap rates and falling values, life companies are generally lending not more than 60% to 65% [loan-to-value], and are focusing on the highest quality properties. Within these constraints, life companies are a good, cost-effective source of debt capital in today's market."
The reality is something with which the commercial real estate industry is starting to come to grips.
John Pelusi, CEO of HFF, one of the largest and most successful commercial real estate capital intermediaries in the country, addressed the topic in HFF's first-quarter earnings conference call.
"There's a clear lack of liquidity for new deals, especially large loans, but Freddie [Mac], Fannie [Mae], the life companies, the balance sheet lenders, are operating at full capacity," Pelusi said. "But they are doing so in a lender-friendly environment. The borrower-friendly environment has gone. Lower leverage, less [interest-only], more amortization, higher spreads; it's the same old rule: he who has the gold makes the rules."
Life companies have not been immune to the capital market troubles. Fitch Ratings in a new report issued this week said it does not expect weakness in the commercial mortgage market to negatively impact ratings for U.S. life insurers. Nevertheless, Fitch said it does expect industry earnings to be negatively affected by an increase in realized losses associated with commercial mortgage-related investments due to increased loan default rates and spread widening.
Commercial mortgages represent an important component of U.S. life insurance company investment portfolios. Fitch estimates that aggregate investment exposure to commercial mortgages for U.S. life insurers accounts for approximately 19% of general account invested assets. Fitch estimates that the industry's exposure to investments backed by subprime or Alt-A residential mortgages equates to 5% of general account invested assets.
Fitch also noted that most U.S. life insurers reduced their overall exposure to credit risk in the narrow credit spread environment of 2005?2006 and are positioned to increase credit risk should commercial real estate become an attractive investment again.
Fitch reported that it believes that many insurers will view the turbulence in credit markets as an opportunity to invest new money at much more attractive spreads, thereby enabling them to offer more attractive products and potentially earn greater levels of investment income.
That is the reasoning behind some new fund raising efforts from Teachers.
TIAA-CREF Asset Management this month launched TIAA-CREF U.S. Real Estate Fund I LP, a closed-end fund that will invest in a diversified portfolio of primarily high-quality core real estate assets.
The U.S. Real Estate Fund I is primarily targeting high-net-worth investors with at least $3 million, said Shawn Paulk, head of TIAA-CREF Asset Management's Advisor Services group.
"This opportunity was formerly only available to institutions and eligible TIAA-CREF plan participants," Paulk said.
The fund has an initial minimum investment requirement of $150,000. A subsidiary that will elect to be taxed as a real estate investment trust (REIT) is expected to make substantially all real estate asset transactions. The term of the fund is seven years after the end of the offering period, which the general partner may extend to a maximum of 10 years.
"At least 80% of our investments are expected to be in high-quality core properties in the 50 largest U.S. markets," said Suman Gera, managing director of TIAA-CREF Global Real Estate and the portfolio manager for the fund. "We intend to use a top-down and bottom-up research approach to select commercial properties, primarily in the office, retail, industrial and multifamily sectors, which are expected to provide a stable, predictable income stream, have high occupancy levels, credit-worthy, financially sound and reputable tenants, and a low or modest level of projected near-term tenant turnover."
The other 20% of the fund's assets will be invested in value-add assets, which include properties that feature generally higher vacancy rates, present more varied leasing opportunities and near-term lease expiration exposure and may require capital infusions to enhance the leasing profile of such properties.
Earlier this month, CoStar reported that TIAA was looking to raise another $5 billion for TIAA Real Estate Account is to invest in real estate properties and mortgages.
The account intends to invest between 75% and 85% of its assets directly in real estate or real estate-related investments. The account's principal strategy is to purchase direct ownership interests in income-producing real estate, such as office, industrial, retail, and multifamily residential properties. The remainder would be earmarked for joint ventures, real estate partnerships or real estate equity securities or mortgage loans.
As of year-end 2007, TIAA's general account had a mortgage and real property portfolio of approximately $22.1 billion. As of year-end 2007, the account owned a total of 111 real estate property investments: 46 office properties, 27 industrial properties, 21 apartment complexes, 16 retail properties and a 75% joint venture interest in a portfolio of storage facilities throughout the United States.