Few market sectors have struggled more than commercial real estate since the pandemic changed how people work and live. A year ago, commercial real estate debt spreads were significantly higher than those of corporate bonds, so insurance investors received compensation for taking real estate risk.
Those spread premiums are lower today. Risk assessments, meanwhile, haven’t changed much. US inflation is still running hotter than expected and rates may stay higher for longer than the market assumed just a few months ago.
But while the interest-rate curve is higher than it was two years ago, it’s also more anchored. This has helped stabilize valuations and has created an environment that is more conducive to investing in real estate.
A Holistic Approach for an Expansive Market
The US commercial real estate market’s equity value was $22.5 trillion at the end of 2023, according to the Federal Reserve, with outstanding debt of $5.9 trillion. As we see it, capitalizing on the potential in such a vast market requires a holistic approach that incorporates opportunities across regions, asset types, collateral types (loans versus physical assets), and public and private markets.
We see opportunities across market segments, including commercial mortgage loans, conduit commercial mortgage-backed securities (CMBS), single asset single borrower (SASB) CMBS and commercial real estate collateralized loan obligations.
In our view, a holistic approach is better than a siloed process that segregates investments into categories—securitized loans in one bucket, whole loans in another and so forth. We think the siloed approach poses more risk of missing opportunities, duplicating exposures or both.
In Real Estate, Debt Seems More Attractive Today
Based on our view of today’s market landscape, we think it makes sense to prioritize debt over equity. Lenders’ seniority in the capital structure provides an important cushion. Equity investors face a higher risk of absorbing losses or, in extreme cases, losing all value—a risk that may grow if Treasury yields remain elevated or keep rising.
For lenders, a higher-for-longer rate environment means loans will likely remain outstanding for longer, which should increase returns. And when rates start to decline, property values and repayment activity are likely to increase.
This helps to explain why lenders have been willing to extend loans to borrowers instead of forcing sales. We expect this to continue. And while asset values have declined, we don’t think many of them have fallen far enough to make acquiring properties sufficiently cheap to justify significant equity investments.
Shorter Loans—a Good Fit for Annuities
Life insurers typically allocate a sizable 20%–30% to commercial real estate, according to SNL Financial, while allocations for property and casualty insurers are a more modest 3%–6%. On the product side, annuity sales have surged in recent years with rising interest rates, outpacing those of traditional life policies and boosting competition among insurers for short- and intermediate-duration assets.
This shift may make shorter-duration commercial mortgage debt a good fit for insurers’ annuity liabilities, which tend to have shorter contract durations than traditional life and long-term-care products. As many as three-quarters of conduit CMBS deals in 2024 sported five-year maturities; trends have been similar with securitizations backed by SASB loans and privately originated whole loans. Similarly, in the whole loan market, insurers have moved toward floating-rate indexed and shorter-duration loans to match the liabilities they’re selling.
Navigating the Credit Cycle: Where We Are
In most cases, sectors such as multifamily, industrial, hotels and retail are in relative equilibrium—a stable stage of the credit cycle. Office, perhaps the hardest-hit sector since the pandemic, is broadly in recovery. But the recovery’s length will vary based on property quality, location and employers’ return-to-office mandates.
And as the following display shows, loan origination volume is at or near pre-pandemic levels for every sector aside from multifamily and office. Compared to 2023, origination last year increased in every major sector except retail.
Focus on Underwriting Quality, Not Property Type
Strong insurance investor demand for yield along with real estate’s value versus non-real estate corporate securities suggest opportunities. But limited growth in net operating income across properties means that the type of building—office, hotel or multifamily—isn’t as important as the quality of underwriting.
Put another way, we think the focus should be on credit features and covenants, not necessarily whether the loan is financing an industrial or multifamily property.
In conduit CMBS and SASB deals, we think it makes sense to look at higher-quality tranches—primarily AAA and AA—despite tighter spreads. In many cases, revenue growth has been offset by rising expenses, keeping net operating margins in check and growth in the low single digits. So, with the credit curve relatively flat, investors aren’t getting much more yield from moving down in quality. We do see opportunities to invest in situations with more perceived risk, moving higher in the capital structure to boost return potential with a significant downside cushion.
On the private side of commercial real estate debt, potential tends to cluster at both ends of the credit spectrum. At one end are income-generating “core” or “core-plus” properties with steady cash flow. At the other end are more opportunistic plays. As with publicly traded debt, we think a flat credit curve means that staying higher in the capital structure may reduce risk.
Quality and geography still matter for investors. Consider offices: the sector is recovering more rapidly in top-tier cities, including New York. And the outperformers are typically newer, energy-efficient buildings with modern amenities and proximity to retail and transit. Their closest analog may be the modern “fortress” malls that survived the shift to e-commerce that started in the early 2000s.
Again, though, leasing terms are typically shorter today, underscoring the opportunity in shorter-duration investments.
The Big Picture: Watch the Risks, but Don’t Pass Up Opportunity
There are risks in 2025. Credit spreads are tighter, and a significant drop in property cash flow would push values down. But we believe that staying up in credit quality, avoiding the riskiest business plans, and blending public and private credit may help insurance investors calibrate commercial mortgage exposure to today’s risks and opportunities.
The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.
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