Despite the prevailing consensus that we are at a late stage in the real estate cycle, some US property debt investors are looking for ways to enhance yield amid reduced returns from the asset class.
Property cycles, which are determined by a combination of demographic, economic and emotional factors, are widely recognised as having two ‘up’ periods: recovery and expansion. They are also recognised as being characterised by two ‘down’ periods: oversupply and recession.
Adam Ruggiero, global head of real estate research and strategy at MetLife Investment Management, believes the US commercial real estate cycle has entered its latter stages. He also notes that, in spite of this, some debt investors are taking on greater risks in an effort to achieve higher yields.
He adds that such investors are often not appropriately compensated for taking on higher levels of risk late in the cycle. “History would suggest that higher-risk loans should carry higher yields than they do today,” he says. “Looking back 10 or 15 years, many of today’s higher-risk deals would have carried another 50 to 100 basis points or more in spread. By comparison, pricing on lower-risk loans still looks attractive.”
His observation is based on data compiled by MetLife Investment Management and the American Council of Life Insurers as of Q4 2018. The data suggest that the spread between AA- and BB-rated commercial mortgage loans has been narrowing: whereas over the last 15 years, it has averaged approximately 70 basis points, it is currently closer to 50.
Allianz Real Estate has launched what its global chief executive officer François Trausch calls “a combined loan” structure to enhance yields. This involves providing development loans for the first two years within a seven-year lending facility.
Last month, he told attendees at our sister title PERE’s Debt Forum in Hong Kong that the company was “trying to find ways to enhance our portfolios to get additional yield”. He added that for Europe-based institutional investors, the most obvious way to diversify portfolios would be to go to the US.
Among Asian investors, Dai–ichi Life Insurance Company announced a $100 million commitment in Q4 2018 to gain exposure to US commercial mortgage loans (CMLs). Its Mercury Series US CML Fund has invested in loans issued by the US-based Protective Life Corporation to commercial properties and to senior housing in the country.
CMLs attain high levels of creditworthiness by securing sufficient real estate collateral against the principal. They can earn higher returns than corporate and other types of bond that have similar levels of creditworthiness.
Nicholas Wong, a partner at Townsend Group, says Asian investors in particular appear to be targeting an increased allocation to US real estate, as well as greater geographical and sectoral diversification. “They are going [towards] debt because of an equity cushion behind it,” he told PDI.