Using insurance companies as lenders
While commercial banks provide the most common form of financing for commercial real estate transactions, insurance company lenders offer another important source of funds. As this lending option remains less well known, it can be helpful to review all its aspects – starting with, why do insurance companies offer mortgages in the first place?
Life insurance companies receive their monthly premiums from their clientele, then must invest those dollars. A number of them choose to allocate a portion of their funds to commercial real estate mortgages.
Commercial real estate and its financing remains an attractive long-term investment option in this country, and those stable returns incentivize certain insurance companies to enter the field.
KNOWLEDGE IS POWER
An important distinction between the typical bank lender and its insurance company counterpart is that while banks often bundle and sell their loans to investors, insurance companies usually keep their loans on book. This means that during periods of market volatility, insurance companies continue lending, while a bank may simply halt its lending programs because of deteriorating market conditions. During an economic downturn, insurance companies become a vital part of the commercial real estate industry, because they continue to provide funds at times when other lenders do not.
The simple act of keeping loans “on book” allows a lender that does it to provide a dramatically different level of flexibility and service. For instance, life company loans are often fully amortizing, meaning no balloon payment, and the borrower can choose the rate reset period. A conventional bank loan is typically three, five, or seven years and then must be refinanced. A life company loan can be 20 or 25 years, with a rate reset every three, five, or seven years – or even longer like 10 or 15. There will be a period of time when the interest rate lock opens, and the rate will reset to market conditions, thus allowing the borrower to avoid refinancing and the costs associated with it.
For instance, a borrower might choose a loan with a 10+10+5/25 structure. This type of loan would be fully amortizing at 25 years, and the rate would be locked for 10 years, then adjust to market conditions and then lock for another 10 years, and then adjust to market conditions and lock again for the final five years. Another borrower might choose a loan where the rate resets every three years. The key point is that insurance company lenders can be incredibly flexible and the terms of a loan can often be negotiated and structured in whatever way the borrower prefers.
OPTIONS ARE KEY
Insurance companies do tend to be more conservative than bank lenders – again, they bear the risk of the loan themselves and don’t pass any of the risk along to investors. Because of this, a borrower should expect a lower loan to value for this type of loan. Between 50% to 60% of the value of the property is the range to expect from this type of lender. If the borrower wants to pay off this type of loan early, there also are pretty significant fees, called yield maintenance. Avoiding yield maintenance is one reason some borrowers prefer to reset the interest rate every couple of years, rather than locking in one interest rate for a long period, like 10 years or more.
Not only can an insurance company lender provide more flexibility regarding the interest rate and term of the loan, there’s also a pretty dramatic difference between the post-closing covenants required by these lenders versus other lenders. Other lenders may have debt service ratios or loan to value ratios that must be maintained to keep the loan in good standing. This can – and did, during the pandemic – provide obstacles to borrowers with properties that stop performing for one reason or another. It may not be enough to keep making the mortgage payment every month, the lender may decide to call the loan due if certain loan covenants are not maintained for the life of the loan.
While each insurance lender is different, the aforementioned flexibility and ability to negotiate remains a key advantage as to this aspect of a mortgage. For example, this author’s firm maintains a close relationship with several lenders that don’t require any post-closing covenants. Keeping reporting requirements to a minimum and the ability to structure a loan as the borrower chooses – along with the ability to negotiate with a lender that maintains control over the loan – stands as rather dramatic distinctions between insurance companies and other more conventional lenders.
Insurance companies that issue commercial real estate mortgages essentially outsource the production arm of their investment teams, meaning they rely on mortgage bankers to find their borrowers. Unlike a bank, where a borrower can have a direct relationship with the lender, an investor wishing to pursue this financing route must go through a mortgage banker. When choosing a mortgage banker to work with, consider the length of time that firm has been in business. The best advantage that a mortgage banker can provide to his or her client is the depth and breadth of lender relationships. These carefully cultivated lender relationships allow a mortgage banker to negotiate the best possible outcome for a client.