Market Data

Life Insurance Companies Reposition to Increase Market Share

Over the past five years, life insurance companies have lost ground in both the equity and debt commercial real estate markets. Competition from commercial mortgage-backed securities has slowed life companies' mortgage originations, and because real estate investment trusts dramatically bid up property pricing from 1985 through mid-1998, life companies have been unwilling to compete.

But the heated competition from CMBS and REIT markets has prompted life companies to reposition themselves in order to survive in the rapidly changing commercial real estate market. The operative phrase for life companies today seems to be if you can't beat them, join them.

Equity Holdings Life companies' commercial real estate equity declined from $50.2 billion in 1994 to $40.8 billion in 1998 - an 18.7 percent drop. This decline can be attributed to the sale of commercial real estate assets owned by a number of life companies, including New York Life, Equitable Life Insurance Co. of Canada, Metropolitan Life Insurance Co., John Hancock Mutual Life Insurance Co., Allstate Corp., and Prudential. Strong market conditions and the desire to hold more liquid debt and equity real estate securities were the main motivations for these companies to sell their equity positions.

Life companies also have not purchased new property because of the high prices caused by REITs. However, REITs' appetite for commercial real estate acquisitions dramatically declined after June 1998 due to waning share prices that caused banks and Wall Street to curtail nonsecured REIT lending. Prices for commercial real estate recently have dipped slightly due to REITs' exit. This has caused some life companies to retain commercial real estate assets longer than anticipated.

Debt Holdings
Life companies' commercial real estate debt holdings decreased from $197.6 billion in 1994 to $193.9 billion in 1998 - a 1.8 percent decline. This 1998 level was up slightly from $189.2 billion in 1997. Despite the increase, the overall life company market share of commercial real estate debt declined from 16.3 percent in 1997 to 14.6 percent in 1998.

To better compete with CMBS, life companies have started their own CMBS programs. Life companies are well positioned to use their origination infrastructure to write mortgages for loans that either are securitized or held in portfolio.

In fact, life companies possess a unique advantage over conduit lenders, which originate more than half the loans that are sold into the CMBS market. Conduit lenders earn income by pocketing the difference in the yield in which they originate and sell loans. The conduit business can be profitable when spreads are stable or decreasing.

But when spreads unexpectedly spike, as they did in fall 1998, conduits often are forced to sell loans at losses because the origination yields are higher than secondary market yields. Because conduits typically operate on short-term lines of credit, they often do not have the option of waiting out market fluctuations.

Unlike the conduit lenders, time is on the side of life companies. Since they have access to long-term capital, life companies can place loans in their portfolio when securitizing loans would be unprofitable. When securitization market conditions change, life companies then can securitize the loans that were being held in portfolio.

Another advantage that life companies have over conduit lenders is greater flexibility of loan terms. Because conduit programs originate loans that are intended to be securitized, the borrower is subject to highly restrictive loan conditions such as bankruptcy remote entity requirements, reserve requirements, and ongoing financial reporting.

In contrast, life insurance companies that plan to hold loans in their portfolio can offer more flexible mortgage terms and a wider variety of loan product than conduit lenders. Some borrowers even are willing to pay higher interest rates in exchange for less restrictive mortgage terms.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.

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