Amidst remote work and rate hikes, Canada's Big 4 insurers manage CRE exposure with resilience
The commercial real estate (CRE) market's pressures, intensified by enduring remote work practices and rising interest rates, present challenges yet resilience among large Canadian life insurers.
The Big 4 Canadian life insurance companies—Manulife Financial Corporation (MFC), Great-West Lifeco Inc. (GWO), Sun Life Financial Inc. (SLF), and iA Financial Corporation Inc. (IAG)—face the downturn with CRE exposures.
Their investments, primarily in commercial mortgages and investment properties, make up 7 percent to 18 percent of their total assets.
This situation, exacerbated by “the durability of remote work” and higher interest rates, has led to a challenging environment for the CRE market, resulting in asset markdowns and increased provisions for credit losses.
Despite these adversities and declining property valuations impacting earnings, the insurers' significant asset base, considerable capital buffers, and the overall positive operating environment suggest that the CRE market's impact on their capital will be manageable, albeit continuous monitoring is warranted.
The remote work trend solidified since the coronavirus pandemic has dampened demand and office space utilization in North America. Coupled with digitalization trends and the green transition, the demand for office space is undergoing significant shifts.
The rapid rise in interest rates further pressures real estate asset valuations.
For the Big 4, office real estate constitutes a weighted average of 40 percent of their CRE property portfolio, translating to 1.5 percent of their total invested assets. About 20 percent of their CRE mortgages are related to office buildings, accounting for 1.8 percent of invested assets.
This exposure is predominantly in North America, with MFC and GWO having limited exposure in Asia and Europe, respectively.
Over the past decade, there has been a significant shift in investment strategies among these insurers, notably with a reduction in the proportion of office real estate within their CRE property portfolios.
Despite this trend, office real estate investments remain substantial, particularly for IAG, which accounts for 85 percent of all commercial properties held.
This exposure is mitigated by high average occupancy rates of 87 percent and the high quality of tenants who often have long-term leases.
MFC's investment in office real estate is also notable at 57 percent of the CRE property portfolio, with a similar occupancy rate and a significant portion used for its operations, thus considered less risky. SLF and GWO's largest proportions of CRE properties are in industrial uses and multifamily buildings, indicating a diversification strategy.
Regarding mortgages, approximately 20 percent of commercial mortgages for MFC, GWO, and SLF are secured by office buildings. Based on updated quarterly valuations, the loan-to-value ratios for these mortgages range from 52 percent to 62 percent.
This equity cushion reduces the risk of impairments, although further repricing and revaluations are anticipated to affect these ratios throughout 2024.
The CRE downturn significantly impacted the Big 4's earnings in 2023, with “lower real estate valuations and increased credit loss allowances for CRE mortgages” exerting more pressure on earnings than adverse credit experiences related to CRE mortgages.
However, the CRE-related write-downs were absorbed by the positive operating environment, characterized by high interest rates and strong performance in the insurance and asset management segments.
Despite potential further CRE market deterioration, the anticipated impact on earnings is manageable, supported by the expectation that high interest rates will continue to bolster returns.
