A clever strategy or a case of fools gold?
The massive financial crisis that hit the economy in 2008 affected the real estate markets. For example, the collapse of Lehman Bros. was, in part, due to its sizable (and highly-leveraged) Commercial Real Estate debt portfolio. These holdings lost significant value causing Lehman's counter parties to question the investment bank's solvency - ultimately leading to its well publicised demise.
More recently, the Bank of Spain has announced that it will have to inject €100 billion into a Spanish banking sector that (over) financed both residential and commercial property during the credit bubble. Like many other announcement about troubled property loans over the past two years, this news has caused shock-waves that have reverberated around the world's financial markets.
It therefore comes as a major surprise to see UK-based insurer - Legal & General (L&G) - venturing into this space with its first real estate debt financing deal in which it is providing £121m in a 10-year loan to a student accommodation developer. The question is why?
This high-profile deal is the latest evidence that suggests insurers may be positioning themselves to reclaim a significant share of the real estate lending market in Europe, despite warnings from experts that Solvency II is now unlikely to push insurance companies towards real estate debt investments as had originally been expected. Solvency II draft provisions had suggested that such investments would be more capital efficient than real estate equity investments but this appears to be no longer the case. As such, these deals should now be significantly less appealing and less logical.
Dutch insurance conglomerate, ING envisages a future with a reduced role for banks and greater lending coming from insurance companies - predicting that by 2015 insurers will provide up to 20% of debt to the real estate sector. Yes, there is clear evidence that the western world's banking appetite for real estate lending is insufficient for the size of the major real estate investment markets but can (and should) insurers fill this shortfall and if so, at what risk to their balance sheets?
Real estate fund managers who must refinance old debt over the next three years may find that task more difficult unless they have long-established relationships with traditional lenders. For those who have collected a 'war-chest', the potential to capture bargin assets in the world's leading cities may be a mouth-watering prospect for any CFO - especially those working for a well funded and cash-rich insurance company. If so, the L&G deal may mark the turning point where insurers take a leading role in the future of real estate financing as Europe's banks rebuild their shattered balance sheets.
However, let's not forget that there is a fundamental difference between insurance risk and banking risk and I have always believed that insurers cross this line at their peril. If Solvency II was the original driver for L&G's decision (to move into real estate debt financing) then they may find that they (and ING) have started down a path from which there is no return.