Though REITs have consistently grabbed the headlines, the nation's insurance companies are keeping stride. Editor's Note: Sometimes in this burgeoning commercial real estate recovery it's easy to overlook the role that insurance companies play in financing the markets. Many observers believe that with the emergence of Wall Street, REITs, securitizations and conduits, they are relegated to snapping up the scraps that remain.

We thought we'd find out for ourselves by inviting real estate portfolio managers from some of the nation's top insurance companies to sit down over lunch and tell how they are competing in today's commercial lending market. Our partner on this roundtable was Washington, D.C.-based Barnes Morris Pardoe & Foster, a leading provider of commercial real estate services in the Mid-Atlantic region. The discussion was lead by Robert Cohen, chairman of Barnes Morris, and myself.

The Discussion Robert Cohen: How does the insurance industry fit into the capital markets arena, and does it have its own plan to compete with those sources of money to invest in real estate?

Michael Kercheval: My particular role is managing the life company real estate portfolio. Equitable Life today views real estate as a tremendous opportunity. They've been out of the real estate market since 1991, and with a change in management and a change in ownership, they see real estate as still a good opportunity to be investing in. This is really across the board, from the public sector, all of the opportunities there and through the private sector sorts of investments. They feel that there are real opportunities.

The catch-phrase that Equitable is using now is relative value in looking at the real estate assets and investing. The way that Equitable wants to play in the market is it will provide an allocation to invest in real estate, but they will look at real estate as everything from REITs to single-B, to triple-B all the way to investment-grade CMBS, equity real estate acquisitions, joint ventures, whole loans, the full gamut of real estate, including in our situation agricultural mortgages and agricultural equities and that's all considered real estate. Then where the dollars are allocated within that spectrum of real estate opportunities will be based on relative value. That's the role we're playing, determining where that relative value is within that spectrum. We're a full-service real estate firm. It's our charge to find the assets that meet that relative value.

Joseph Springman: At CIGNA we've been in the debt business fairly actively through the downturn, through the depression, whatever you want to call it. It's sort of slow and steady with us, so we're investing pretty much the same amount of capital in the debt side that we had in the last four or five years. On the equity side, we're emphasizing our acquisitions for an open-ended separate account, and that account has been actively investing now for about three or four years.

Our view of the market is that things are in pretty good shape nationally. We think most property types, with the obvious exceptions, don't seem to be oversupplied. We think there's fairly even sentiment among investors whether they're buyers, sellers or holders. We don't see an excess of development pressures anywhere. We do see some more risk taking obviously. One of the trends on our debt side, obviously our margins are not as good as they were two or three years ago. They're not scary yet. People are active. I would say though that compared to two years ago, it's a much better borrower's market today than it was, by far. In fact I think the borrower has the advantage today. There's so much competition on the debt side. On the equity side, competition is very much the story.

Susan Lewis: I run the real estate area for all of The Travelers Insurance Cos. so that's both life and property casualty. We basically manage an existing book of business as well as trying to look for new opportunities in real estate. I agree with the comments thus far in that the opportunities are good but the spreads are very tight. The risk/reward seems to be getting a little out of balance with pricing being extremely thin on some of the lower-risk deals. We've basically taken a little different approach since we have a sister company that is a Wall Street firm in Smith Barney. We've really taken a look at the whole capital structure, so we're doing debt but we're also looking at equity deals and some lines of credit, some floating-rate deals, which is not typical, I don't think, for a life company. So we prefer pooled collateral, we prefer to get some diversity in the deals that we're doing as opposed to maybe the historic one-building, one-mortgage type of approach.

We've done lending to REITs, and we like the major markets. Many of the suburban markets are on fire and the pricing there is so tight we can't compete with most of you guys. So we've tried to do a little bit more niche business, floating rate debt and bridge loans and things of that nature.

Michael Mannix: I manage John Hancock's general account assets in debt and equity. It's about $10 billion, $8 billion in mortgages and $2 billion in real estate, half of which was acquired via the mortgage route in the past five years.

John Hancock has historically been, amongst the life companies, one of the highest ratios in real estate as a percentage of its assets. As a result of regulatory pressures over the past four and five years we've brought that down considerably. We're not uncomfortable with real estate. We continue to have a very active debt arm. Our intention is to put out as much this year as we have during our heyday. Additionally we see opportunities created by the secondary markets. Last year we "massaged" about 37% of our then $8 billion portfolio through either swaps or REMICs or some vehicle to take advantage of what we see in the secondary market. I think that traditionally life companies were holders of these assets. You made a mortgage and you expected to have it for 10 years come hell or high water. We've been through high water ... So really the secondary market represents an opportunity for us.

We're not despondent about Wall Street's entree into what has traditionally been our business. We think there are advantages to being taken there and we welcome that. On the equity side, this is an opportunity for us right now. We see this as a good time to consider selling a good many of your assets. But at the same time we have a desire to hold assets that we won't be able to replace in terms of their ability to produce returns.

Thomas McCahill: I'm with MONY Real Estate, which is basically the real estate group for Mutual of New York. I oversee their portfolio both on a debt and equity basis throughout the U.S. MONY has taken a fairly contrarian approach to the real estate market over the last couple of years in terms of the amount of properties that we got back and whether we were just going to dispose of them to address some balance sheet issues or whether we were going to hold and asset-manage them.

We found that our strategy has paid off really well for us in the last couple of years, particularly as you've seen the onslaught of the REITs come into the equity markets, most recently of course on the office side. We happen to have a preponderance of our investments in the office portfolio. So from an equity standpoint, we are basically trying to address the balance sheet issues with risk-based capital, and trying to, in an orderly fashion, bring down the percentage of real estate investments we've got as a percent of our assets at large. Over the last couple of years we'll have sold, once we complete some of our dispositions this year, about a billion dollars in equity transactions.

We view ourselves on the debt side really as being a value-added type lender. We have pretty well shied away from commodity blue-chip type real estate where frankly we don't think the spreads warrant the risks that we're taking. There are others who have different opinions of that, but we basically view ourselves as hands-on real estate people, the regional office network where we've had real estate professionals go through a number of cycles, and think that we're there to solve problems and we're comfortable taking some risks.

Dennis Francis: I head up the real estate operations at Principal Financial Group. That includes all commercial real estate activities, debt, equity, what little REIT activity we had, and CMBS.

As far as the commercial real estate market today, I think that clearly the recovery is well under way. When you take a look at most of the markets, most of the property types today, you are within a year of equilibrium. Some markets reached equilibrium six months to a year ago. As a result of that, you've seen a pretty significant increase in rents and values on a lot of properties in a lot of these markets over the last year. As a result of the market re-finding commercial real estate now as an investment medium, you've seen a lot of capital flowing, both into the debt and into the equity markets.

As far as what we are doing, we continue to have a large appetite for commercial real estate loans. We've averaged close to $2.5 billion a year for each of the last four or five years, even during the downturn. We were very active in the debt markets. Our senior management did not give up hoping that commercial real estate was a good medium, and while a lot of companies were on the sidelines we were aggressively trying to do about as much as we could physically do, which in retrospect worked out to be a wise decision. We also during the downturn, foreclosed on a lot of properties and, like Tom was mentioning, we chose not to sell. We did not do loan restructures. Now we're looking at these markets today and we think the timing is right to start selectively selling. This year we are looking at selling probably $300 million so we're stepping up the pace a little bit.

Walter Korinke: We've never slowed down on our debt level. Our objective is to maintain about 15% of assets level on the debt side. We were one of the first of ya'll back into the equity business in '91. As folks were departing we were coming in and it turned out to be an extremely good time to be buying. Actually buy low/sell high works for once. How unique. About '93 we started doing developmental and that was about 40% of our equity business and to this year our interest is virtually 100% developmental. By that I mean spec development. I don't know how much life is left to this.

Right now construction is at a fair basis out there with a few exceptions like Atlanta's going hog wild on office right now. But generally there may be another year or two or three left where this could make some sense. I like salting my portfolio with property at a higher yield function than what I can buy on the street where I can replace some of my older, lesser yielding ones this way. I have flipped a few contracts where we never even funded a dollar right at the end. And that dirty word ordinary income actually sounds pretty good to the life company. I think we've got another two or three good years. After that I refuse to forecast.

Kenneth Hargreaves: Our primary focus is on the private markets, both debt and equity. We work through a regional office system. Talking about the equity markets first, we do that investing through Cornerstone Realty Advisors, that's a wholly owned subsidiary we established about three years ago to focus completely on real estate equities. They have a very focused strategy we call rotational or repositioning. They focus only on office buildings or hotels. We're actively buying hotels and suburban office buildings.

Moving over on the debt side, this is where we really stress that we want to avoid the heard of competition because there is always somebody out there who will do something foolish when you get 10 or 15 lenders quoting on a deal. It's really driven us over the last year to have more of a barbell strategy. On one end of the barbell is a hotel where we're financing a hotel getting paid for the risk. We know there's a higher risk. At the other end would be a regional mall where it's a 50% loan to value and we know it's a very secure deal, but we're willing to price it for a very secure deal.

Quickly on the public side, we were very active in the CMBS market up until the middle of last year, then we became a net seller. We felt buying triple-Bs at 200 over was a good pricing risk. When it got down to 110 and in that range that was not a good reward. So we've essentially been a net seller in that market today.

Mason Ross: I run the real estate operation at Northwestern Mutual, which is about a $13 billion portfolio, give or take, two-thirds in debt and a third in equity. We remain today very active in both the debt and the equity markets. On the debt side we're actively doing construction permanent lending, long-term lending on a variety of property types, deal sizes from $10 million to probably $120 million. We have in the last year or so shared some transactions with other large life companies where the transactions were in the $150 million to $200 million range. That's worked out well, and it's been competition for Wall Street and these deals otherwise would have gone to the Street.

I share some of the thoughts about the health of the markets. In general supply and demand looks pretty good across the country. We're beginning to see a little bit of overbuilding in some of the apartment markets, beginning to see some spec building in some of the office markets, but the early people in will do fairly well and if it continues too long then some people will get hurt a little bit. We're concerned about the massive amount of capital that is coming into real estate right now.

Northwestern did stay active during the downturn on the debt side and the equity side and stayed in both those markets over the last five years. We were particularly active on the equity side, investing between $500 million and $1 billion a year in new equities over the last three or four years.

One other point, we are active in the public markets and have a fairly active REIT portfolio with about $500 million which we've built over the last three or four years, both public and private REITs, and that's probably about as large as it's going to be in terms of a percentage of our assets. It's been a good place to be and we're beginning to get into the CMBS market.

Cohen: A lot of you have been touching on the public markets. Is it an individual or industry strategy of percentages you would invest in REIT mutuals or REITs?

Ross: I don't think insurance companies in general are going to be active players in the REIT market. The reserve requirements are very high. In general insurance companies are not active players in the common stock business anyway. We do a little bit, but there are so many limitations on what portion of your portfolio can be in publicly traded stocks, be they REITs or otherwise.

Hargreaves: That's on the equity side. If you're talking REIT debt that's something else. Where historically we've provided on one-off properties, now we're doing pools of financing for REITs, pools of properties. Sometimes it's unsecured, sometimes it's secured.

Lewis: We've seen situations where we lend to REITs on a private pricing basis. They get big enough to get a public debt rating and all of a sudden they have access to funds that are half the price of what we might customarily lend to them. So you've done all the work to understand the assets and the assets are the same assets that you underwrote.

Mannix: I would wholly agree. For the last couple of years everybody's been concerned that our market share was going to be eroded by conduit business or the Wall Street business. As a company we find that to be an attractive business. We're out there , hopefully, gathering in more and more mortgages all the time and we're going to enter that business. More of a threat to market share is really the REITs. They're taking our prime product as life companies right out of the marketplace. I agree that you have the option of being perhaps a middle-term unsecured lender to that organization, but if it succeeds, they're going to be out on the street with a public offering that we're not going to find attractive at least on our side of the house. And their appetite is increasing and increasing. With regard to whether they are overpaying or are overvalued, they're leveraging, and they're leveraging at some pretty attractive prices.

Cohen: Do you think the REITs are going to be back in the development business?

Mannix: That really depends on how the street continues to react toward the REITs. If they continue to put pressure on the REITs to grow at astronomical rates, then the REITs will be forced to enter development to be able to compete against each other for the stock dollar. I'm hoping that isn't the case. I'm hoping that the analysts on the street decide that at some point in time that a stable REIT is better than one growing in an unstable environment.

Francis: One concern about the REITs is that they may need to grow faster than what their income can grow with the properties they have in their pools now. So as long as they have this positive leverage, this arbitrage between their cost of capital and what the income from the properties can throw off, they're going to be aggressive to buy properties. But I think also they're going to be tempted to aggressively develop properties because I think they are going to aggressively try to keep their stock prices up.

Dennis Francis, Principal Mutual; Susan Lewis, Travelers Insurance; Kenneth Hargreaves, Massachusetts Mutual Life Insurance Co.; Thomas McCahill, MONY RE Investment Management; Michael Kercheval, Equitable RE Investment Management; Michael Mannix, John Hancock Mutual Life Insurance Co.; Walter Korinke, Lincoln Investment Management; Mason Ross, Northwestern Mutual Life Insurance Co.; Joseph Springman, CIGNA Investments Inc.