Invesco Global Real Estate Debt: A source for diversification for insurers
Why should Insurers consider Real Estate Debt?
Real Estate Debt offers yield and diversification benefits coupled with reasonable capital requirements
- In the current low yield environment with compressed spreads in public bond markets, Real Estate Debt is an attractive alternative to public bonds.
- Senior Real Estate Debt investments offer higher rates of return when compared to corporate bonds of similar credit ratings.
- Real Estate Debt provides portfolio diversification benefits versus both equity and bond markets, and also versus direct real estate, due to the specific value drivers of individual properties.
- Insurers may capture the diversification benefits within an internal model, or within the ORSA1 for those insurers with standard models.
- Senior Real Estate Debt markets exhibit a loan to value (LTV) which is lower than 60% compared to an average of just 40% for corporate bonds.
- Senior Real Estate Debt is secured against an underlying property which serves as collateral and could offer a higher recovery rate than the typical corporate bond recovery rate (40%).
- Real Estate Debt is the most common private debt investment allocation by insurers, and is forecast to see increases in the future2.
Footnotes
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1 Own risk and solvency assessment.
2 EY asset manager survey 2020.
Investment risks
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Underlying real estate can be difficult to sell, hence potentially having a negative impact on the real estate loans they guarantee for. The value of the underlying real estate is generally a matter of an independent valuer’s opinion and may not be realized; the value of the real estate loan is significantly influenced by the underlying real estate. Changes in rental yields for the underlying real estate, interest rates and general economic conditions may result in fluctuations in the value of the real estate loans and of the portfolio and potentially (floating-rate loans) in the cash-flows generated; fixed-rate loans with long maturities are more exposed to values fluctuations. Real estate debt investments and portfolios may be exposed to counterparty risk, which is the risk that a counterparty is unable to deal with its obligations. Many Real Estate debt investments are illiquid, meaning that they may not be sold quickly at a fair price and may need to wait until maturity before having the investment recovered. The strategy may use derivatives (complex instruments) and borrowings, which may result in the portfolio being significantly leveraged and this may cause large fluctuations in the value of the portfolio. Real estate debt investments can be exposed to new sustainability-related regulatory requirements that may negatively affect the value of those investments which are not compliant and can envisage significant costs to be invested to comply or to simply improve their sustainability profile. In addition, real estate debt investments can be also significantly exposed to negative economic effects stemming from climate change, natural disasters, and the general preference of investors for investments with better sustainability features. Real estate loans are typically non listed on regulated markets and need to be valued via the application of appropriate models (potentially applied by independent experts): this may lead to inaccurate valuations which may not be reflected into transaction prices. Real estate debt portfolios are exposed to credit risk which is the risk of inability of the borrower to repay the interest and capital on the scheduled dates and at maturity. Loans or loans’ tranches with lower seniority (mezzanine, junior) bear a higher credit risk as those loans falls behind more senior ones in the repayment queue; the risk may be exacerbated in times of stress. Commercial mortgage lending is generally viewed as greater risk than residential mortgage lending since the repayment typically depends upon the successful operation of the underlying properties.
Important information
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Data as at 30 September 2020, unless otherwise stated.
Where individuals or the business have expressed opinions, they are based upon current market conditions, may from those of other investment professionals and are subject to change without notice.
