US insurers target European commercial real estate debt
American insurers are increasing their investment in UK and European commercial real estate (CRE) debt, as domestic insurers struggle to meet burgeoning demand.
Large US groups, including New-York-based MetLife and Massachusetts Mutual (MassMutual), have been quick to fill the void left by European banks’ withdrawal from long-term financing, hoping to take advantage of yields on CRE loans that are more attractive than those available in North America.
In March, MetLife announced it had become the largest portfolio lender in the insurance industry in 2012 with $43.1 billion in commercial mortgages, of which $1 billion was for UK properties. This included a $264 million loan on the Broadgate West office complex in London and a $200 million loan on a portfolio of retail units.
Also in March, Cornerstone Real Estate Advisors, part of the MassMutual group, said it planned to expand its CRE financing operations in France and Germany. It had entered the European CRE market in July last year, partnering with Laxfield Capital to originate and manage fixed rate loans in the UK of between £25 million and £75 million in size.
Paul Wilson, London-based regional director, real estate, at MetLife Investments, says: “What’s driving it is that CRE lending has become very competitive in the US very quickly again, but it still feels like there’s opportunity in the UK and Europe for US lenders to get some additional spread.”
He adds: “There’s been pretty dramatic growth in the past two years. It wasn’t until the financial crisis hit that the market opened up and gave us an opportunity to pursue these sectors full throttle.”
The more fragmented market in the US means US insurers typically have fewer reservations about exploring CRE opportunities in other jurisdictions. Prior to the financial crisis, around 90–95% of the CRE debt market in Europe was catered for by banks, whereas in the US there was a more even distribution between banks, insurers and commercial mortgage-backed securities (CMBS) investors, according to Axa Real Estate.
Analysts say US insurers’ greater expertise in CRE financing has allowed them to become established in this space faster than their European peers as finance from banks has diminished. Justin Curlow, senior research analyst at Axa Real Estate in London, says: “With such a historically bank-dominated market in Europe, as soon as you take away that supply of loans, it allows new lenders to come in and take advantage of the market’s supply-and-demand imbalance.”
The influx of US interest is expected to boost European insurers’ investment in CRE debt. A large proportion of European CRE loans are three-to-five years’ duration, which does not perfectly suit the needs of life insurers, which prefer longer-dated assets to back their liabilities.
With banks exiting the markets, experienced insurance investors are attempting to negotiate longer maturities with debtors, which in turn is encouraging more European insurers into the loan market, according to David Dowling, director, insurance and pensions solutions, at Deutsche Bank in London. “[Insurers’] hands have been strengthened massively by the banks coming out of the market. What we see is if we have a five- or seven-year transaction to place, insurance companies will come to the table and try and negotiate a longer term with the sponsor,” he adds.
Longer maturity loans could slowly become the norm as insurance players become established in the CRE debt market. MetLife’s Wilson comments: “We lend across a spectrum from three years to 15–20 years plus. We have the majority of our lending spend in the five-year space, filling the gaps left by the banks. That’s what borrowers in the UK are used to. But that might change over time as borrowers become more flexible around insurer-type lending.”
The illiquidity of CRE debt compared with fixed-income assets of the same credit quality boosts the yields achievable on these instruments, making them an appealing choice for insurers hunting for return in the low interest rate environment.
The spread over Euribor/Libor typically ranges from 250–350 basis points on prime European CRE debt at present, according to Charles Daulon du Laurens, head of investor relations for CRE finance at Axa Real Estate in Paris. This compares favourably with spreads on equivalent US assets, which MetLife’s Wilson estimates yield 50–75bp less than their European counterparts.
But these record spreads could begin to narrow, says Laurens. “This [current spread] is an all-time high premium. The opportunity has never been, from a relative return point of view, this attractive. A number of market participants, including ourselves, expect these spreads to start compressing for the very best assets. It is likely they will not stay this exceptionally high in the coming years,” he says.
There are already signs that insurers will have to range wider geographically in order to sustain this level of return on CRE debt in years to come. Andrew Berman, co-head of European insurance and pensions sales at Deutsche Bank in London, says: “The demand for prime south-east UK and London properties has driven the yields down on these quite substantially. As yields come down, insurers looking for UK CRE exposure may decide to broaden their horizon, looking at opportunities outside London where the reward profile may be more attractive. Examples of this could be Birmingham or Manchester.”
For now, though, MetLife at least is happy to stay focused on the opportunities available in the UK. “We’re still pretty happy with the prime UK market, which is mostly London. We find portfolios from prime borrowers outside London, but we haven’t really had to stretch too far to meet our goals in terms of production and spread,” says Wilson.
This article was first published on Risk