Robust borrower demand for credit and constraints associated with certain traditional sources of supply create opportunities in commercial real estate debt investments for insurance companies, said Pacific Investment Management Co. LLC, or PIMCO.
Speaking during a webinar co-sponsored by S&P Global Market Intelligence, PIMCO representatives quantified the area of unmet borrower need at between $50 billion and $60 billion, generally involving higher-leverage, floating-rate loans on quality assets.
Devin Chen, executive vice president and co-head of PIMCO's U.S. commercial real estate team, said banks have generally been selective in their commercial real estate lending activity and the amount of leverage they will advance to a borrower, given changes in the regulatory environment. The commercial mortgage-backed securities market remains "a fraction of what it was" prior to the financial crisis, he added, and it is susceptible to volatility. Predictable cash flows are also important in the CMBS market, creating an element of what Chen described as structural inflexibility.
On the demand side, Chen said, high levels of investor interest in commercial real estate assets and transaction volume suggest a significant need for credit in the private markets.
"Life insurers are a huge presence in CRE lending, but the vast majority of what they do tends to be low [loan-to-value] loans mostly on properties in major metropolitan-type markets," said PIMCO Senior Vice President Justin Ayre. Chen added that there is "a lot of competition" among traditional lenders for those types of loans.
The "sweet spot," as Chen sees it, involves senior or so-called "stretch-senior" loans of between $75 million and $200 million on transitional properties in prime markets and stable properties in secondary markets.
"This is where you can pick up some additional return, we think, but assuming you have the underwriting capabilities and you structure these loans properly, you still have very strong downside protection," he said. "That's where we think the liquidity gap exists."
Executive Vice President Carrie Peterson-Brown said that while PIMCO as a firm maintains the position that "we are in the later innings of the commercial real estate cycle," it does not anticipate a material decline in pricing in the near term. In major markets, she said, PIMCO has begun to observe a pullback in prices, but it still sees value in what she described as nonmajor markets. Peterson-Brown offered cities like Austin, Texas, and Dallas along with "submarkets" such as Oakland, Calif., and Brooklyn, N.Y., as examples of nonmajor markets where PIMCO continues to find value.
"There is cause for some defensiveness as we talk about some of those prime, top six MSAs, but there still are attractive opportunities at this stage in the cycle," she said.
Chen said sourcing is critical for insurance companies as they consider investments in commercial real estate debt. It allows them to structure loans as they see fit and to maximize the economics of the transactions. It also provides certainty of execution from the borrower's perspective, something Chen said is "of particular importance" in the current environment.
Ayre said that while commercial mortgage loans have accounted for an increasing amount of the unaffiliated investments held by life and property and casualty insurers over the past decade, exposure to real estate overall has declined as commercial and nonagency residential mortgage-backed securities represent smaller portions of their overall mix. As a result, total real estate exposure was lower in 2016 relative to aggregate unaffiliated investments than it was in 2008.
Peterson-Brown recommended a "nimble" approach that includes the pursuit of the types of loans Chen described and opportunistic investments in certain legacy CMBS.