L&G: An insurer’s policy

In the hunt for yield, Europe’s insurers are increasing their exposure to commercial real estate debt. UK institutional stalwart Legal & General is among them.

In January, the London-based company hired Blackstone and Royal Bank of Scotland alumna Lorna Brown to lead the debt side of its real estate operation as it attempts to grow its presence in the market.

Legal & General Investment Management entered the property lending space in 2012. Figures relating to its origination activity are hard to come by, although the firm’s website refers to a real estate debt portfolio of around £2.2 billion (€2.5 billion) as at 30 June 2017.

Among UK property debt market participants, there is a perception that LGIM’s lending activity has been on a more modest scale than some of its insurance market competitors, with the emphasis weighted towards equity investment.

“Bringing in Lorna Brown, allowing her to grow her team, is a statement of intent,” suggests one London-based real estate debt advisor, speaking privately. “They are a large group, so they should be able to compete with their peers.”

Insurers are becoming more agile lenders. LGIM’s domestic rival Aviva Investors, for example, now lends fixed and floating-rate money, while M&G Investments – a subsidiary of UK insurer Prudential – lends third-party money across the capital stack. Germany’s

Allianz is growing its UK presence and aiming to provide development loans.
LGIM’s real estate lending sits within the firm’s Real Assets division, within a sub-group known as Private Credit. As part of an interconnected group, Brown’s aim is to grow the scope of the insurer’s lending activity.

“When the team was set up in 2012, there was a desire, shared by many insurers, to access property debt as an investment class. The next stage now that I have arrived is to increase the profile and penetration into the market,” says Brown, discussing her new role. “We aspire, at the right price and risk point, to continue to grow further.”

There are no set lending targets, Brown insists, but asked about the scale of LGIM’s ambitions, she points to the fact LGIM Real Assets’ managed assets total around £27 billion today, of which real estate debt accounts for not more than a 10th. “We think there’s an opportunity to increase the relative balance with further real estate debt investments,” she says.

LGIM’s property lending unit will not dramatically reinvent itself, Brown insists. Rather than rethink the product range, it will stick to its senior lending roots, taking a more “creative and flexible” approach to underwriting and lending.

PERCEPTION

Insurance companies are often perceived to be lenders of low-risk senior debt, lent on decades-long tenors to a narrow range of property types. Brown suggests that LGIM’s lending to date has not subscribed to that model and the firm is a more flexible lender than some in the market might assume.

“We’ve written shorter-dated loans outside the mainstream property classes,” says Brown. “We can be competitive in terms of price, the type of debt and the speed at which we can make decisions.”

Notable among last year’s loans was a three-year deal provided to investor GreenOak Real Estate – a loan tenor more usually associated with banks than institutional lenders. The £39 million loan, written at an all-in interest rate of 2.4 percent, also underwrote an element of letting risk, backing GreenOak’s transitional business plan for the mixed-use property in London’s Whitechapel area.

Another relatively short-term deal was the seven-year facility provided last June to Citygrove, financing three office buildings in regional English locations.

Last April, LGIM provided a large property loan to Deutsche Finance International and Yoo Capital for the £296 million purchase of the historic Olympia London Exhibition Centre. LGIM did not reveal the size of the loan, although it is understood to be £162.8 million for a five-year term. Size aside, the deal was notable for being the team’s first acquisition financing, following several refinancing deals.

“We look to underwrite senior risk, but we are able to look at short and long duration loans on a range of properties including operational assets,” Brown explains. “We can back assets subject to active business plans; it’s what people might expect of an alternative lender. We are happy to be a primary originator, to be in club deals or to purchase positions. This allows exposure to the primary and secondary markets.”

As a lender of insurance money, the current focus is on fixed-rate lending. From there, LGIM can underwrite a range of scenarios, with a focus on income. “We need to see an existing or future income stream,” Brown explains.

She adds that managing long-term insurance liabilities provides insurers with the continued opportunity to finance those looking to lock-in finance for longer terms than banks offer. “In Europe, people are questioning whether interest rates will rise, and that creates an opportunity.

“Investors who are looking for strong cash income return or family offices seeking wealth preservation may think about refinancing now and securing a longer-term facility that allows them to take advantage of current interest rates and loan margins.”

One of LGIM’s largest reported deals is the £175 million, 15-year loan for the UK-based hotel owner Arora Group, provided in October 2016. “In the last couple of years, some sponsors have looked for longer term debt,” Brown says, adding pricing on these loans can be “very competitive” because of the longer-dated positions the lender can take.

As is the case with many lending organisations outside the banking sector, LGIM’s property lending unit is lean, but with expectations to grow in the short term. Brown’s team includes Ashley Goldblatt, who has been with LGIM since the launch of the lending strategy, and a third colleague. A challenge many alternative lenders face is replicating the client-side abilities enjoyed by banking teams. Brown acknowledges this is a priority for LGIM.

“It’s important to have a market facing origination platform to generate deals. For me, the ability and appetite to build out this platform was one of the real appeals of joining LGIM,” she says.

Another strand of the business, aside from investing in-house client money, is growing its external capital sources. In 2015, the firm expanded into advising third-party clients for a complementary lending strategy. Today, the LGIM Real Assets Private Credit business manages more than £1 billion in external mandates.

INSURERS’ ROLE

The role of insurance capital in the European property debt markets is growing. Since the financial crisis, central banks have flooded the financial system with cheap money to stimulate investment. In turn, bond yields have been under pressure. Property debt, by contrast, has offered more attractive returns, and insurers have been gradually incrementing their exposure to it.

However, despite structural changes in the lending market, banks remain the single biggest lender group in Europe, holding over 68 percent of market share and leaving it considerably less diversified than the US, where more than 40 percent of debt is originated by non-bank lenders, according to the Investment Property Forum.

The lending report previously published by De Montfort University and now by Cass Business School, showed that by the half-year mark of 2017, insurers held around 14 percent of the UK’s £166 billion market, originating more than £1.5 billion of new lending in the first six months of the year.

“Insurance companies invest in the real estate debt market in many ways, including via debt fund platforms. However, the majority of UK real estate debt – more than 75 percent – still originates from the banking market. I think there’s opportunity to increase the provision of debt from insurers and offer borrowers further choice in their lenders,” says Brown.

Insurers have typically focused their investments on conventional bonds, but with yields low due to the European Central Bank’s quantitative easing programme, real estate debt has become a more attractive alternative. In addition, while access to property returns was typically gained through buying CMBS bonds in the last cycle, Solvency II regulation, which attaches high risk-weighing to such products, has made direct lending more attractive to insurers.

Real estate debt is a natural asset class for insurers, she adds: “Insurers are keen to find fixed-income products to match their liabilities and seek a range of investment durations. The return premium relative to public bonds makes real estate debt an attractive asset class for investors.”

Others have the same idea, as 2017’s spike in institutional fundraising for property debt strategies showed. “Current capital raising in the market is for a range of different debt products, with money being raised for senior, mezzanine and whole loan lending. I think this diversity of debt products aids the liquidity in the market and helps the overall real estate market to function.”

LGIM’s renewed focus on real estate debt comes as investor demand for the asset class is high. Expectations as to what an insurance company can provide from a property lending perspective have also changed. There is a considerable opportunity, but also increased competition.

Knowledge of real estate markets, Brown adds, is crucial. “I see debt as just another tool through which to invest in real estate. Ultimately, you have to be able to underwrite the real estate risk.”

Brown’s journey to L&G

Prior to joining LGIM, Lorna Brown’s real estate career included roles at Royal Bank of Scotland and US private equity firm Blackstone.

From 2012 to 2018, her role at Blackstone Real Estate encompassed sourcing and managing investments across the debt and equity sides of the business. “Early deals included investing in performing and sub-performing loans, but there was also new debt origination.”

Brown joined RBS in 2001 after a stint as a chartered surveyor for DTZ. “I joined at a time when the bank was engaging in a range of transactions, including equity participations and joint ventures, so the role involved structuring and underwriting real estate debt and equity.”

From 2009 to 2011, following the global financial crisis, Brown was tasked with establishing a real estate restructuring team within RBS, a role she describes as part of the effort to “get to grips with the extent of the bank’s real estate risk in the UK”.

The insurance part of the sector is new to Brown, although she comments that, at this stage in the cycle, the market needs investors and lenders with a long-term view. “It’s a time for patient capital.”

LGIM’s debt business: Under one umbrella

The debt elements of LGIM’s real estate, infrastructure and corporate strategies sit together as the Private Credit division of the firm’s Real Assets business. In total, Private Credit deployed around £2.7 billion last year, with around £7 billion of debt assets now under management.

The property debt business launched in 2012, followed by infrastructure debt in 2013 and corporate credit in 2016. The three areas came under the auspices of Nicholas Bamber from 2016, with the overall LGIM Real Assets business led by Bill Hughes.

An expansion of Private Credit was announced in January, with three senior hires: Brown on real estate, Stuart Hitchcock as senior portfolio manager and Matthew Taylor as senior investment manager in corporate private debt.

“People see the links between real estate and infrastructure and so it makes sense to group together areas of the business using and creating assets and investments that feed into everyday lives,” says Brown.

Working alongside the real estate equity investment team is also important for the debt business. “Our real estate debt team will use the expertise of the wider real estate platform to create an integrated equity and debt business.”