Our Perspective 9/ 1/ 2021

Capital Corner: Life Companies – Never too big, too small, or too short

Despite the impact that the COVID-19 pandemic has had on some sectors of commercial real estate, life insurance companies are actively lending with a strong appetite for new business, which is benefitting borrowers.

With plenty of capital yet to be deployed for the year, many life companies are boosting their allocations compared to last year, adding new flexibility for the length and size of the financing structure.

There are several interesting dynamics at play today. First, as the economy is reopening and travel is becoming more acceptable, some life companies are making their first trips since COVID-19 hit and are out in the market. Many are boosting their lending activity.

The second dynamic is life companies are expanding their focus beyond multifamily and industrial – the two most resilient asset classes during COVID. Although the office sector still faces some uncertainty, more capital is returning for office. As companies are beginning to bring employees back to the office after working remotely for 18 months, life companies may be looking at financing solid suburban office transactions, for example.

Meanwhile, essential retail has performed well during the pandemic, and now some retail segments are rebounding, spurring interest from more lenders. Life companies are looking at grocery-anchored retail, and some location-specific retail assets with services for example.

New entrants into the market
In addition to the traditional players, newcomers are entering the space. In some cases, these companies are newly formed, and in other instances, companies have consolidated and increased allocations to deploy capital.

There is also more foreign capital coming in through life insurance companies seeking yield as these groups are attracted to the solid fundamentals of the U.S. commercial real estate market.

The bottom line is many lenders are competing, resulting in aggressive pricing and lenders looking to get creative. It is an evolving landscape as allocations and deal appetites change.

NorthMarq has loan production and loan servicing relationships with more than 50 correspondent life insurance companies. We continue to have dialogues with our core life companies as well as new entrants. Across our network of offices, we have the inside track of what is occurring in the capital markets.

Capital programs have become more dynamic
What has changed significantly is in previous years, when life companies had a set allocation and program of what they wanted to do, they put their game plan together, executed on the game plan through the calendar year, and restarted the next year.

However, it is totally different today as the capital markets and programs are more dynamic and quickly changing. Life companies are now asking us where the opportunities are, so we are consulting the capital and the borrowers, which is unique. We are in the middle of it all. Because it is so fluid, we are helping life companies put together a game plan based on our experiences and what we are seeing in the market.

How are life companies getting creative?
Lenders are continuing to chase yield, but how they do it may differ lender to lender. Life companies each have their own approach to how they evaluate new business.

For example, some life companies are doing construction to permanent financing while others will even do new joint venture equity for industrial and multifamily deals. This chase for yield is driving them to look to different areas so the short-term and long-term match up with the asset-liability mix. We are seeing life companies be innovative and really play in all areas. This creativity, varying terms, and floating fix are alive and well in the market today.

If a borrower has a transaction that fits the “strike zone” of the life companies, yields are in the low 2s, there is full-term interest only, flexible pre-pay on the loan term, and accretive leverage. If owners hit that strike zone, life companies can probably offer the most competitively priced capital in the market today.

Competition is a boon for borrowers
It is an ideal time to be a borrower in terms of very accretive leverage and good terms and a large number of high-quality groups chasing the transaction. These groups pursuing deals are practically changing on a weekly basis as to who is the most aggressive, or the quickest to find a new niche market. It is a constantly evolving market.

This makes it even more imperative from a borrower’s perspective to have a capital markets team that can navigate through this ever-changing environment.

Construction perm loan is a product for owners looking for long-term financing without having participation risk on the banking side. Borrowers can select a one-stop-shop and not only dial in a good accretive construction loan but a good long-term loan as well.

The interesting dynamics here are the going-in leverage, the ability to lever up post-stabilization, and the terms, which are full-term interest-only at certain leverage points as well as a coupon, that in some instances, is well below a construction loan rate that borrowers would obtain from a bank.

In one example, the developer of a $52 million, 288 unit to-be-built multifamily in Port Charlotte, Florida, was able to lock in the interest rate for the construction and long-term operation phase of the financing at application, reducing personal equity and risk and meeting the financial goals of the project. Susan Branscome, managing director in Cincinnati, and Bob Hernandez, managing director in Tampa, teamed up to identify the right life company lender relationship to fit this assignment, where the loan and preferred equity piece totaled 85 percent of the capital stack.

Short-term loans have significantly changed in 2021 in terms of the number of life companies that have pushed into both short-term fixed and short-term floating.

From a leverage perspective, the real takeaway from life insurance companies on the short-term side is they are playing at higher leverage points and winning from a standpoint of traditional leverage long-term bullet loans. However, life companies are also very good at the short term, higher leverage, value-add across different product types.

Life companies as aggregators of capital are out raising money so they have short-term capital like any of the debt funds, and they can deploy it as part of their arsenal.

One example was a stabilized industrial portfolio of 12 properties totaling 2.5 million sq. ft. that required acquisition financing complicated by a number of issues, including tenancy changes impacted by the pandemic, its size, and the tight timeframe to close. The borrower bought these assets to add to their already sizeable portfolio, which had a three-to-five-year hold timeline.

Michael Chase, managing director of the Boston office, targeted three potential life company lenders who had previously financed assets with this borrower, knowing that the familiarity from both sides of the transaction would mean a smoother, faster process in underwriting, appraisals, and closing documents.

Deals of this size and profile see pretty aggressive quotes from life companies since industrial is second only to multifamily assets in their targets for lending. The pricing was aggressive, and the yields were tight. But what was most important to the borrower was the rate-lock at application and over the seven-year term of the loan.

In addition, as the correspondent for the life company, Northmarq was able to have control over third-party engagements, with two-week turnarounds in appraisals, quick approvals on leasing changes, and seamless onboarding to Northmarq’s loan servicing platform.

Long-term loans have been life insurance companies’ bread and butter. The life companies, with the products they sell, will continue to have a need for long-term debt.

The cheapest cost of capital from a life company today – again, for that strike zone — continues to be in multifamily and industrial. Whether short term or long term, the cheapest coupon and the most dialed-in on the terms are going to be in those two product types.

For long-term financing, life companies can really tailor to the needs and requests of the borrower. There is plenty of room for life companies for long-term financing, as the agency lenders don’t have an interest.

In a recent example, a single-tenant CVS pharmacy under construction in an infill Denver neighborhood landed with a life company offering to rate lock at application below 3.5% interest rate. Because the tenant was so interested in this specific location, they were willing to sign a 25-year lease starting upon the expected November 2021 closing date. That lease drove the 25-year, fixed-rate financing program consistent with the borrower’s business goals of estate planning, cash flow, and asset preservation. Ultimately, Matt Franke, senior vice president – Houston, said a life company with strong interest in single-tenant net lease properties offered the strongest rate and relationship for the borrower.

Life companies are primed for solid production for the remainder of 2021 and into 2022 with an abundance of capital and aggressive pricing.