By Bob Donhauser, Senior Managing Director, Holliday Fenoglio Fowler L.P.
Recent months have seen resurgence in the strength of the commercial real estate lending markets. Of particular note is the return of the life insurance companies and their willingness to quote sub-5.5 percent coupons on lower-leverage (under 65 percent) loans, with high quality sponsorship, collateral and location.
A shortage of acceptable quality deals and unwillingness to stretch on loan-to-value parameters has forced life companies to tighten spreads to compete. Life companies have also begun to get comfortable with larger loan amounts, with significant competition in the $40-$60 million range and a select group actively making loans above $100 million. As recently as six months ago, few life companies or banks were willing to lend more than $50 million without the need for syndication. Instead, foreign lenders were dominating this niche and achieving above market risk-adjusted returns.
The return of life insurance companies to commercial real estate lending has been spurred by recent rallies in the equity and bond markets, a perception that the worst of the recession is over, and pressure to produce returns. First, rebounds in the stock and fixed income markets have made the relative value of life companies’ investments in commercial real estate fall below their desired allocations. This imbalance in investment allocations is referred to as the “denominator effect” and caused many life companies and other investment managers to cease investing in commercial real estate when markets were crashing in 2008 and the beginning of 2009. Now that real estate investments are below their desired allocation, portfolio managers are giving their lending groups more money to deploy. Second, life companies have begun to get comfortable with commercial real estate valuations. Although they still view high leverage loans (75 percent+ LTV) as too risky, they do not believe a further drop in prices will occur that could put 60-65 percent LTV loans at risk of significant value deterioration. Third, life companies are under pressure to achieve yield on money currently sitting idle. Portfolio managers realize that they can achieve desirable risk adjusted returns in commercial real estate lending and are willing to compete on rate, which does not materially affect their risk profile. On the other hand, they are unlikely to compete on proceeds and risk lending on a higher loan-to-value ratio.
As rates are driven down by competition from life companies and increasingly from banks and revived CMBS lenders, life companies may begin to raise acceptable leverage levels to historic norms of about 75% on strong deals. Rising treasury rates and continued stagnant job growth, however, could keep this trend from becoming a reality, as lending rates will rise with treasuries and real estate fundamentals traditionally mirror the job market.