Why insurers are delving deeper into real estate as low interest rates linger

Oct 27, 2021

THE prospect of higher and stable returns from real estate continues to woo insurance firms globally in the face of persistently low interest rates.

Insurers and their property arms have been snapping up stakes in physical assets, pumping capital into real estate funds, acquiring equity interests in property investment firms and developers, and providing real estate-linked loans.

To be sure, this trend is not entirely new. But as the "too low for too long" rate environment looks here to stay, insurers are revving up the pace at which they pursue real estate and other alternative, higher-risk investments, in the hunt for better returns.

In June, Ping An Life Insurance inked a 46.7 billion yuan (S$9.6 billion) deal to buy stakes in six Raffles City developments in China from CapitaLand.

Pointing to the "high-calibre tenants and stable rental income" of the six properties, the Ping An unit said it expected the investment to "offer a stable and good return".

CGS-CIMB analysts then estimated that the deal was concluded at a historical net yield of 4.3 per cent, based on a net property income of 1.9 billion yuan generated in FY2020.

A Citi research note, cited by Reuters in August, said that the insurer's total real estate-related exposure was around 185.5 billion yuan, weighted roughly equally on equities, debt and investment properties, and making up about 4.8 per cent of Ping An's total investment portfolio.

Another recent example was South Korea's biggest insurer Samsung Life acquiring a 25 per cent stake in Savills Investment Management (Savills IM), a subsidiary of real estate services provider Savills, for about £63.8 million (S$118.67 million) in May.

Then just this October, global investment manager GLP raised 311 billion yen (S$3.68 billion) for the largest Japan-focused private real estate fund to date.

It attracted commitments from insurers, pension funds and sovereign wealth funds in North America, Asia and the Middle East.

BlackRock's global survey of senior insurance executives in June-July last year found that nearly half of the respondents were targeting higher yields or returns, in repositioning their portfolios. Some 32-40 per cent of the executives also expected to increase their allocations to commercial real estate equity or debt in the next 12 to 24 months.

Interest rates skidded at the height of the Covid-19 pandemic early last year, with yields on the benchmark US 10-year Treasury note collapsing to unprecedented lows, as investors dumped riskier assets and flocked to safer options.

Policy responses, via massive quantitative easing, pressured rates even lower globally.

Although interest rates have since largely recovered to where they were before the pandemic, they are still at historically low levels. This has deepened long-term payout pressures for insurance firms.

Insurers' profits tend to be vulnerable in a low-rate environment because their assets and liabilities are heavily exposed to changes in interest rates. In particular, the life insurance business is more sensitive to rates, as savings products and long-dated contracts dominate the sector.

Paul Brenchley, partner, head of insurance advisory at KPMG in Singapore, noted that many life insurers issue policies offering coverage for a long duration, sometimes up to 25 years. Some of these policies are also sold with the promise of guaranteed investment returns.

"In light of this, long-dated assets offering high yields are needed to deliver insurers the returns required to meet policyholders' obligations," he said.

Interest-earning bonds and other fixed-income securities thus make up the bulk of insurers' investments. But in tandem with rates, bond yields have been stubbornly subdued.

"The current low interest rate environment has weakened the ability of new bond issuances to provide consistent and regular cash flows to cover insurers' liabilities," Brenchley said.

In response, insurers are increasing their investments in alternative assets. "High-quality property and property-related assets offer relatively stable cash flows from rental income, and also offer investments that can be held long term to match the longer-term liabilities held by many life insurers," Brenchley added.

RHB analyst Vijay Natarajan noted that given the low interest rates, the ability to borrow cheaply has also helped to boost yields. Moreover, insurers can take a long-term view due to the nature of their business, and real estate as a long-term asset class thus sits well in terms of matching their insurance liabilities.

"Overall, we expect the trend of insurance companies taking passive or active stakes in real-estate investments to continue in the medium term," Natajaran added.

Lee Nai Jia, deputy director of the Institute of Real Estate and Urban Studies (IREUS), observed that insurers have been actively looking for real estate assets, especially office and logistics products.

"Insurers are seeking real estate assets that have provided higher yields and shown resilience against the uncertainty from the pandemic," Dr Lee said.

In addition, the insurance industry has garnered more sales lately, which likely also spurred demand for real estate assets, he added.

Still, even as property's appeal grows, insurers - and investors in general - ought to take a cautious and measured approach. KPMG's Brenchley said: "Direct investment into property can be illiquid as properties take time to sell; this will negatively affect insurers requiring short-term cash. This was seen during Covid-19 where some assets suffered falls in rental income due to a lack of occupancy."

In 2019, with rates already at record-low levels and facing a structural decline even before the pandemic, Natixis Investment Managers noted in a research report that "a decade of ultra-low interest rates has inflated institutional liabilities and widened the duration mismatch for insurers across the globe".

"Desperate for alpha, investment teams are turning to private equity, private debt, and other alternative investments to fill the void left by meagre bond returns," Natixis added.