The Case for Life Company Loans in a Shifting Climate

The season is changing, the cycle is shifting and much of the change is feeling positive for commercial real estate financing across the board. Finally, we are seeing sustained improvements in the overall rate climate. Occupancy and performance metrics have remained relatively stable and resilient for most asset types through the rate volatility of recent years, at times even improving (take office for example). Where softening, it’s mostly from recent high marks: think industrial and multifamily rents, which have seen healthy bumps in rates in the post- COVID years even in if pockets of softening have emerged.

Through it all, life companies have remained the consistent, trusted and timely source for commercial real estate debt, especially as banks retreated from the marketplace in the early days of rate volatility. Improving market conditions means competition amongst debt sources is heating up again. The return of banks to active originations is increasing available liquidity, a telltale sign of these improving times. There is also strong competition for the life companies from CMBS lenders, agencies and even debt funds in the bridge space.

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As a dedicated life company correspondent, Gantry is constantly called in to provide insight into the life company option in comparison to other sources. Even with this vested status, we do not ignore the multitude of debt sources and options available to borrowers. Commercial mortgage banking requires putting the client needs first, and that means we place debt with all lender types. We know it can require a deep dive to identify the best fit for a borrower’s specific needs. In that process, it is worth considering where life companies shine and how they stack up against the other options in the market today.

Life companies

Life companies shine for several reasons, historically and in the current cycle. Their non-recourse terms and the ability to rate lock for up to six months at application have long been a competitive advantage. These time-tested lenders are also known for their certainty of execution, consistent and reliable servicing and requiring no impound or reserve accounts. Traditionally known as a tried-and-true resource for stable, long-term, fixed rate, low leverage permanent debt, these lenders have stepped up their flexibility, moving into shorter three- and five-year terms and bridge loans to meet market demand. They are also more than willing to offer some form of interest only for loans meeting DSCR requirements.

Positive movement in treasury yields promises to make their longer-term loans more attractive again and could create new momentum for traditional 10-year loans. In the interim, they have introduced five-year and fixed rate bridge programs to secure higher yields and offer clients shorter terms popular in today’s market climate. Life companies are most active in multifamily, industrial and grocery-anchored retail, have an appetite for self storage and increasingly for office. They are most comfortable in primary and, at times, secondary markets where asset quality and performance warrant.

Banks

Banks are back after a two-year hiatus and actively competing again for both stable loans and construction debt. They are a sponsor-driven lender also known for attentive servicing and typically are comfortable in their local markets, which can include primary, secondary and even tertiary locations. However, they are a recourse-driven execution (sponsor-driven) and require at least an operating account for most if not all their loans. Their willingness to step back from the onerous additional deposit requirements of the past two years has made their debt more attractive than at any recent time. Banks will often require performance-related covenants that can hamstring an operator during times of stress. They are, however, competitive on spread and offer variable rate loans that can provide greater reach into the capital stack. Expect interest only terms to be available when DSCR meets necessary thresholds. Banks lend across all the major asset verticals, and are comfortable across the A, B and C-quality asset profiles if they are comfortable with a credit-worthy sponsor.

Agencies

The GSEs continue to be a dominant source for financing in the multifamily space, particularly on assets of B quality and below. Rightfully so since that is what they’re designed to do. However, life companies still present a compelling option for qualifying assets, with their streamlined underwriting and rate lock at application. Agency paperwork is extensive and must be uniform to move forward through to closing, a challenge for time-sensitive needs.

Life companies are essentially done with paperwork at application. There is an early lag on rate lock with agencies after application, which can be impactful in a volatile rate cycle. Agency debt is also, ultimately, a bit more expensive even at similar term length and benchmark due to the way they process interest payments between pay periods. Life company payment structure is based on 365-day calculus. Agency payments are based on the actual number of days between pay periods. Same monthly payment cycle, but principal and interest are calculated differently as agency principal pays down at a staggered pace, resulting in an approximate 7bps difference in ultimate loan cost. Agencies are also far less flexible on servicing, although their loans are relatively conservative to perform under stress.

CMBS

The revitalization of CMBS required the introduction of five-year loans in a space once dominated by the 10-year term. For assets looking to maximize the last available dollars, CMBS continues to grow in popularity even with its more labor-intensive execution and B-piece risks during underwriting that can radically alter pricing or scuttle a financing entirely. However, CMBS loans are often full-term interest-only and can underwrite from an I/O DSCR. CMBS loans are also mostly non-recourse, but unlike life companies do not lock-rate until the final day of closing, making them somewhat risky until the final moments in a volatile rate climate. CMBS is an option for all the major asset classes, but is best suited for loans on larger multifamily, office, industrial, self storage and hotel properties. Servicing for CMBS loans is well known for being inflexible and distant, making this execution ultimately more about the money and less about the experience when combined with underwriting.

Debt funds

A wave of capital has moved into commercial real estate debt funds seeking yield and anticipating a wave of distress creating opportunities through dislocation. Debt funds historically don’t compete much with life companies until the life companies saw an opportunity to pick up yield with shorter-term bridge debt in face of the decreasing market for long-term debt allocations. Where debt funds compete with life companies in this bridge space, they have decidedly more flexibility in underwriting unique terms to specific asset plans. This flexibility will often come with a price, and a variable rate tied to SOFR. They are also mainly a non-recourse execution and are more focused on the exit strategy than sponsor quality. For construction loans, debt funds mainly compete with banks. Life companies are more inclined to look for construction-to-permanent loans when financing new development, a model that is not appealing to debt fund return targets and has really been rather quiet in general during the current cycle. Servicing reputations are as varied as the many types of debt fund operators in the marketplace, but more flexible than what you might find with any other type of lender based on their unique controls and yield targets.

Capital markets

Unlike other tough cycles in CRE, lenders have stayed mostly active and competitive on new originations through this volatile rate climate post-COVID. Life companies are not the only option by far but should be considered a preferred execution for qualifying assets for their many strengths. Most amortizing maturities can find a satisfactory loan solution to refinance, and as rates have stabilized and improved, we have seen price discovery align with their DSCR requirements in a return of investment sales and acquisitions. The steepening of the yield curve and overall drop in yields have benefited all lenders, but particularly life companies. I expect in the months ahead we will be quoting permanent life company options to borrowers seeking the best execution with the maximum dollars at a fixed-rate alongside their traditional bank and CMBS options or debt fund possibilities.

Stephan Coste is senior director for Gantry.