The same higher interest rates that are hurting typical commercial real estate market players are helping life and annuity issuers make great investment deals.
John Murray, a portfolio manager at PIMCO, talked about the effects of the health gap Wednesday at S&P Global Ratings' 40th insurance conference in New York.
"Everyone in the real estate industry is very sad," Murray reported. "Everyone here seems happy."
Joseph Wittrock, chief investment officer at Security Benefit Life, gave a reason for the mood gap at another session.
"We sit in the luxurious position of having capital to deploy," Wittrock said.
What it means: Most of the life insurers backing clients' life insurance policies and annuity contracts have plenty of cash to invest, and they're in a good position to get great deals on commercial real estate investments.
Commercial real estate: Before COVID-19, real estate investors were structuring commercial real estate deals in a world where interest rates were very low and demand for office space was strong.
In 2020, work-from-home policies implemented to slow the spread of the pandemic cut many employers' need for office space. Many owners took out mortgage loans with very low interest rates for a duration of a few years. The owners planned to replace those loans with similar loans. But now, occupancy rates are lower and interest rates are higher, and refinancing the old loans is difficult.
In 2022, the Federal Reserve Board and other global central bankers began to fight a return of inflation by sharply increasing the interest rates they control.
As a result of the shifts, Murray said, office building values are down sharply.
Many building owners are putting off efforts to refinance mortgage loans or make other changes for as long as possible, but the building prices involved in the deals that do close are down 25% to 40% from 2021 prices, Murray said.
Amy Stepnowski, chief investment officer for the Hartford, said how possible buyers and tenants look at buildings has changed.
"There's not a lot of demand for Class B properties," she said.
Even buildings that were seen as attractive Class A properties before COVID-19 may not have as much appeal today, she said.
Few banks, REITs or CMBS managers are in a mood to invest much, and the regional banks that have focused on commercial real estate have been hit especially hard, Murray said.
"I would expect to see more bank failures," Murray said.
Gary Bhojwani, the CEO of CNO Financial, warned against assuming that the office market is at the bottom and will recover quickly.
CNO itself recently cut down to about 30,000 square feet of office space in Chicago, from 140,000 square feet before the pandemic, and it replaced about seven buildings at its Carmel, Indiana, headquarters with 250,000 square feet of space.
"There are tons of companies doing that," Bhojwani said. "I think this is the small knife. The big knife hasn't shown itself yet."
Because so many players are cutting back on lending, for any would-be borrowers wanting financing, "insurance companies are the only game in town," he added. "It's a great time to be a solution provider."
The economy: Meanwhile, for life and annuity issuers, overall conditions are great. North America has avoided the recession that most people were expecting, and "the United States is hitting the ball out of the park," said Paul Gruenwald, S&P's global chief economist. "We going through an investment boom."
Carmi Margalit, S&P's life insurance sector lead, told attendees that the higher rates have helped life insurers write the most profitable business in a decade, capital levels are high, and, at most life insurers, commercial real estate portfolios are relatively small and performing well.
In theory, a spike in interest rates could cause customers to pull cash out of life insurance policies and annuities, but the industry has just gone through a dramatic rate spike that led to no troubling wave of disintermediation, Margalit said.
The gameboard: Sachin Shah, the CEO of Brookfield Re, the company that just bought American Equity, said life insurers have a natural advantage in this kind of market because they need long-duration liabilities and can avoid selling properties during downturns.
"You have to have a really long view," Shah said.
Roger Crandall, the chairman of MassMutual, agreed that the life insurance industry is well-situated to get through the commercial real estate crash.
But "there's plenty of pain to come, particularly in office," Crandall said.
A view of Manhattan, from Midtown looking west toward the Hudson River. Credit: ALM
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