BlackRock zeroes in on dramatic insurance cost increase

The cost of insuring commercial real estate properties in natural disaster-prone areas rose 20% year-on-year in 2022, per an October report from BlackRock.

The cost of insuring commercial real estate properties in natural disaster-prone areas rose 20 percent year-over-year in 2022, per an October report from BlackRock, and commercial real estate lenders are increasingly concerned these increases will affect borrowers’ ability to service loans.

Insurance costs have typically been a largely quantifiable part of commercial real estate transactions, but floods and forest fires in major US markets have made this metric more unpredictable, Alex Symes, head of US real estate research and product strategy at BlackRock, told Real Estate Capital USA.

“We’ve seen [climate risks] contribute to rising insurance costs across all property types, [and] you can really see it by geography, where insurance costs in Florida and California have increased much more so than New York or the upper Midwest,” Symes added.

Insurance costs typically make up about 1-3 percent of a property’s income, according to the BlackRock report. This means a 5 percent annual increase in a premium will have a 10-basis point impact on a property’s internal rate of return. “A one-time increase will not affect the total return of a property very much, it’s whether [the costs] will continue to rise at a very accelerated rate,” Symes explained.

As the impact of climate change becomes more apparent, lenders are increasingly starting to voice concerns about the impact the cost will have on a property’s cashflow, said Kristin Repp, managing director of Dallas-based brokerage CBRE’s valuation and advisory services across South Florida.

“If a borrower’s expenses have gone through the roof, they may no longer be meeting the covenants of their loans and required debt coverage ratios. This could result in their loan technically going into default,” Repp said. “[Insurance costs] are now on lenders’ radar far more than they had been in the past. The increased costs result in more challenging underwriting on new deals.”

While rent growth could help to offset rising insurance costs, this may not be an effective solution, noted Peter Gordon, chief investment officer of the US commercial real estate debt team at Nashville-based manager AllianceBernstein.

“It’s difficult to assume how rent growth will impact the general net operational income in the longer term, and lenders will also evaluate [in their underwriting] if the expenses will grow faster than income,” Gordon added.

The borrower side

Ian Bell, managing principal and CEO of New York-based multifamily manager Olive Tree Holdings, says higher insurance costs mean the firm is evaluating deals in a different way.

“You’ve seen insurance pricing increase from what may have been $200 per unit in 2017 and 2018 to north of $1,000 a unit in some of these coastal markets. It’s unfortunate, but they’re making them unattractive from an investment stability perspective,” Bell said.

Olive Tree regularly evaluates the potential for an area to have catastrophic events while scoring risks for its portfolio, with Bell noting insurance pricing is sometimes not only based on the underlying loss propensity of the property.

“It’s not just losses, [but] also future potential losses that [insurers] are trying to underwrite into their models,” Bell added.

The consensus is that insurance costs – and climate risk – will continue to affect lending and investing on a market-by-market basis. Parts of Florida remain an area of considerable concern for lenders and borrowers, noted CBRE’s Repp.