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Insurance Spotlight: Diversifying and Enhancing Real Estate Debt Portfolios

For insurers, targeting less-trafficked segments of commercial real estate can offer diversification, attractive yield potential and deal structures that are attractive against liabilities.

With traditional lenders focused predominantly on senior loans secured by stable, core real estate, investors can potentially benefit by targeting less-trafficked segments of the commercial real estate (CRE) lending market. For life insurance companies, CRE loans may complement existing high quality commercial mortgage exposure, allowing access to different borrower profiles and loan structures as well as more attractive yields. For property and casualty (P&C) or health insurance companies, CRE loans may offer attractive yield potential and diversification and, in some cases, deal structures may be attractive against their shorter-duration liabilities.

The following Q&A explains the potential opportunities we see in private CRE debt markets today.

Q: How are insurers currently utilizing CRE debt in their portfolios?

A: Insurers in general are active investors in CRE, which includes real estate debt. However, the nature of the exposure varies significantly by type of insurer. 

Life insurance companies as a whole allocate 19% of their investment portfolios to real estate (see Figure 1). This allocation is heavily weighted toward commercial real estate (rather than residential) and more specifically commercial mortgages, which total 11% of general account investments. Life insurance companies’ long-dated liabilities give them the ability to invest in longer-duration and less-liquid parts of the real estate debt market, which makes commercial mortgages a natural match. While life insurers have a large presence in the CRE lending market, most of this exposure is in core, stable properties in major metropolitan areas and at lower leverage levels (typically with loan-to-value ratios in the mid-50% range).

Figure 1 shows two pie charts, which each represent the allocations to real estate for life insurance companies versus health and property and casualty insurers as of December 2016. On the left, the pie chart shows how the allocation to real estate makes up 19% of the overall general account. That compares with just 7% for health and P&C, represented by pie chart on the right. For life insurers, the chart shows how commercial mortgage loans make up about 11% of the general account, and more than half of the allocation to real estate. By contrast, the chart for life and P&C insurers shows that commercial mortgage-backed securities make up the largest allocation to real estate, at 2.7% of the general account, more than other categories such as commercial mortgage loans, real estate alternatives, and non-agency residential mortgages.

By contrast, property and casualty (P&C) and health insurance companies have smaller allocations to real estate, averaging about 7%, most of which is in publicly traded securities, including commercial mortgage-backed securities (CMBS) and non-agency residential mortgage-backed securities (RMBS). Only about 1% of their portfolios on average is allocated to commercial mortgages; this is for a variety of reasons, including shorter-duration liabilities, which necessitate a more liquid investment. Additionally, risk-based capital requirements for direct holdings of commercial mortgages are less favorable than for securitized mortgages.

It is interesting to note how the mix of real estate investments has changed since the financial crisis. Figure 2 shows that allocations to real estate debt have declined since 2008; this is mainly because new issue volumes in non-agency RMBS and, to a lesser extent, CMBS have fallen significantly. In fact, the second chart in Figure 2 highlights a clear shift from public debt (securitized) to private debt (direct loans). This in part reflects declining capital market activity from banks related to increased regulation and reduced risk tolerance, but it also points to the demand from insurance companies for private debt, which can offer illiquidity premiums as well as the ability to customize structure and terms. We believe the trend toward private debt will continue – and we think the less efficient areas of the CRE lending market can be a sustainable source of investment opportunity.

Figure two shows a bar chart and line graph to illustrate the change in insurers’ real estate allocations from 2008 to 2016. A bar chart up top expresses the change as a percentage of unaffiliated investments over the time period. The bar chart shows that in 2016, the level was around 14%, the majority of which was comprised of commercial mortgage loans.  That’s down from 18% in 2008, at which time commercial mortgage loans were still the largest segment, but made up less than half of the unaffiliated investments. On the bottom, a line graph shows the mix of private versus public real estate investments as a percentage of unaffiliated investments. The line for public is below that of private for most of the chart. By 2016, public makes up about 5%, down from 11% in 2008, while private comprises 10%, up from 9.5% over the same period. The lines for public crosses beneath that of private in 2009.

Q: What is the environment for CRE lending today?

A: We see an imbalance in the current lending environment. Although banks and insurers are actively lending, they are highly selective and directing capital predominantly toward stable assets in core markets that are perceived to be liquid. This has led to an uneven recovery in CRE prices. Overall, CRE prices have risen over 23% from their previous market peak in 2007; however, we have seen a 39% increase in major markets and only 16% in non-major markets (source: RCA Commercial Property Price Indices as of December 2017).

The other traditional CRE financing sources are the housing agencies (e.g., Fannie Mae and Freddie Mac) and the CMBS market. The agencies have a narrow mandate focused primarily on multifamily housing and to a lesser extent senior living and healthcare, and within these areas, they lend to stabilized assets. The CMBS market, which saw higher new issuance volume in 2017, is still down more than 60% from its pre-crisis levels. Additionally, CMBS pricing remains highly subject to market conditions, and transaction structures in general are not very flexible (e.g., they can include standardized loan terms and third-party servicing requirements, etc.) and are predominantly fixed-rate outside of single-borrower single-asset deals.

At the same time, demand for credit is robust. The amount of U.S. private equity real estate capital raised in 2017 was an all-time high, and refinancing activity was strong (see Figure 3). Additionally, while transaction volumes were down about 10% in 2017, they are expected to remain well above historical averages.

Figure 3 features two bar charts showing the amount of capital raised in U.S. private equity and transaction volumes by year, over roughly the last 15 years. On the left, a bar chart shows that U.S. private equity capital raising was at all-time highs in 2017, at around $150 billion. Since 2003, when about $25 billion was raised, the chart shows the figure climbing in all years except four of them. A bar chart on the right shows robust transaction volume in 2017, forecasted to be about $450 billion, near the historical highs of about $500 billion reached in 2015 and 2007. Volume climbs steadily after a low of about $40 billion in 2009, to its peak in 2015, before declining slightly to its 2017 level.

Q: What is the real estate debt opportunity for insurers?

A: The supply-demand imbalance has resulted in an estimated $50 billion‒$60 billion of annual borrower demand unmet by traditional lenders. Insurance companies (and other private capital) can step in to meet this need. We believe the best opportunity is in financing loans on value-add or transitional assets owned by high quality sponsors. Many of these loans may be for assets outside of the top central business district markets, where there is less competition to lend. From a credit perspective, the loans are predominantly floating-rate, with loan-to-value ratios of approximately 60%‒75% (also known as stretch senior loans).

For a life insurance company that can take on the additional risks, these loans may complement existing high quality commercial mortgage exposure by offering different collateral profiles and loan structures ‒ and more attractive yields.

For a P&C or health insurance company that has the risk capital and wants to expand beyond  its more limited exposure to CRE, the loans may offer attractive yields and diversification from fixed income and equity portfolios. In some cases, deal structures (e.g., floating-rate and shorter-duration) may also be attractive against liabilities.

Q: What differentiates PIMCO’s approach to CRE lending?

A: PIMCO utilizes a cycle-tested underwriting strategy that includes an internal assessment of the  underlying real estate collateral, local market conditions and sponsor quality. We also follow a disciplined and systematic approach to loan terms and covenant packages. Our team of more than 35 dedicated CRE investment professionals has deep experience across the spectrum of commercial real estate. We leverage our experience as an active real estate equity investor to form our view on value and risks and aim to maximize value for potential problem loans.

As a global investment manager, we have access to the depth and breadth of market information that can help identify attractive real estate financing opportunities. PIMCO’s proprietary analytics and macro insights provide a unifying framework for evaluating investments, which, in conjunction with asset-level analysis, differentiates our approach from others.

Q: How can insurers access this opportunity?

A: While larger insurance companies typically have internal staff to directly originate loans, most do not focus on stretch senior lending or target loans collateralized by transitional assets, which can require significant underwriting and asset management resources. As a result, many work with a third-party manager. Direct holdings typically have more favorable risk-based capital treatment but may require a higher degree of monitoring and infrastructure than most insurers have.

Commingled vehicles (drawdown vehicles) are an approach we focus on at PIMCO. They can simplify the investment from the insurance company’s perspective (e.g., accounting and infrastructure), align manager and investor incentives, and may have favorable risk-based capital treatment, depending on the type of insurer. Importantly, commingled vehicles offer these advantages in addition to the potentially attractive returns on private real estate loans.

Carrie Peterson-Brown and Alex Ade contributed to this article.

The Author

Justin J. Ayre

Account Manager, Financial Institutions Group

Devin Chen

Portfolio Manager, Commercial Real Estate



Investments in commercial real estate debt and mortgage loans are subject to risks that include prepayment, delinquency, foreclosure, risks of loss, servicing risks and adverse regulatory developments, which risks may be heightened in the case of non-performing loans. Investments of this type may involve speculative practices that will increase the risk of investment loss.  Investments in commercial mortgage and asset-backed securities are highly complex instruments that may be sensitive to changes in interest rates and subject to early repayment risk. These investments are also subject to real estate-related risks which include new regulatory or legislative developments, the attractiveness and location of properties, the financial condition of tenants, potential liability under environmental and other laws, as well as natural disasters and other factor beyond an investor’s control. Structured products such as collateralized debt obligations are also highly complex instruments, typically involving a high degree of risk; use of these instruments may involve derivative instruments that could lose more than the principal amount invested.   Equity investments may decline in value due to both real and perceived general market, economic and industry conditions, while debt investments are subject to credit, interest rate and other risks. Floating rate loans are not traded on an exchange and are subject to significant credit, valuation and liquidity risk. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Management risk is the risk that the investment techniques and risk analyses applied by PIMCO will not produce the desired results, and that certain policies or developments may affect the investment techniques available to PIMCO in connection with managing the strategy.

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