Lenders eye impact of rising insurance costs 

Commercial real estate lenders are increasingly concerned about the impact that rising insurance costs.

Commercial real estate lenders are increasingly concerned about the impact that rising insurance costs in natural disaster-prone areas could have on sponsors’ ability to service loans. 

Insurance costs have typically been a largely quantifiable part of commercial real estate transactions but flooding and forest fires in major US markets have made this metric more unpredictable, market participants told Real Estate Capital USA. 

In a September report, New York-based manager BlackRock tracked a 20 percent year-on-year increase in insurance costs in 2022. The report found that insurance costs have historically made up less than 3 percent of a property’s gross income. 

Alex Symes, head of US real estate research and product strategy at BlackRock, said the real question is whether this trend will persist. “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.” 

Even though this phenomenon is fairly new, lenders are concerned about the impact the cost will have on a property’s cashflow, said Kristin Repp, managing director of CBRE Valuation & 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. “I think [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.” 

Rising costs 

Ian Bell, managing principal and CEO of New York-based Olive Tree Holdings, said rising insurance costs means some deals are less attractive than they used to be for some assets. 

“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,” he said. 

Instead of being an afterthought, the high insurance cost has become a major part of the transaction from the forefront of a deal, Repp said. 

“We have seen incidents where deals have fallen through due to high insurance costs. After obtaining the estimates for the insurance premiums, the deal no longer makes sense,” Repp said. The increases CBRE has tracked in Florida are in the 20-30 percent range and the firm has also seen some properties where costs are 100 percent higher than last year. 

Inflationary pressures have also increased the replacement costs of properties, a metric that is also typically tied to insurance premiums. Increasing risks of natural disasters and limited reinsurance capacity are among factors that drive insurance costs to continuously rise, Symes added. 

Climate risks 

According to BlackRock’s report, insurance costs have increased much more in natural disaster-prone regions than in others. 

“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 said. 

Courtland Eyrick, managing director of CBRE Valuation & Advisory Services across North Florida, said the entire state of Florida is bearing the burden of higher insurance costs though certain areas are more vulnerable than others. 

“South Florida is sticking out into the middle of the ocean and the hurricane will cross that whole area, but North Florida property owners are paying the increased premiums just like [those] in South Florida,” Eyrick said. 

More commercial real estate operators take the risk of natural disasters into account when they evaluate the risks of their properties. Olive Tree Holdings’ Bell said his company has been focusing on the propensity for an area to have catastrophic events while scoring risks for its portfolio. 

However, the 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 said, adding that insurance companies sometimes will create a cushion to prevent them from being in a loss scenario. 

Mitigate the costs 

One way that borrowers can mitigate the rising insurance cost is to negotiate the premiums with insurance companies using third-party or independent valuation. 

“Historically, you took the insurance company’s word about what they were saying the replacement cost of your property was worth, and that was tied to your premium,” said Eyrick. 

“As a more prevalent option, you’re seeing independent companies providing a valuation of replacement costs for individuals.” 

However, Eyrick also noted many Florida sponsors are getting dropped by their insurance carriers as insurers leave the state for fear of losses created by increasing natural disaster risks, so there may not be many shopping options for better premiums. 

On the other hand, depending on the lease structure, borrowers can mitigate the excessive expenses on insurance costs by securing rent growth. 

“[Rent growth] is the number one way to mitigate rising insurance costs. We are now more closely evaluating real estate demand in areas where insurance costs are at greatest risk of rising,” said Symes of BlackRock. 

The insurance costs added one more variable to the complex demand-supply balance, where landlords should also consider to what extent tenants can absorb these extra costs. 

“You can pass that through to your tenants up to a point until they turn around and say, that’s great, but we need a lower rent,” said Alex Killick, managing director at CWCapital Asset Management.   

As for the outlook on whether the rising insurance cost will persist, analysts said there hasn’t been enough discussion on the topic nor possible solutions. 

Analysts also noted that the insurance cost is one of the many challenges commercial real estate managers need to navigate now. With elevated interest rates, rising construction costs, and tightened lending into the market, rising insurance costs became one of the moving pieces that both borrowers and lenders should take into account to make deals pencil.  

“I think the insurance crisis in Florida is going to be ongoing. To what level, no one knows. I’m hopeful, going forward, that the annual increases won’t be as dramatic as we’ve seen this year,” said CBRE’s Repp.