Soaring Insurance Costs Could 'Paralyze' CRE, So Investors Are Calling For Reform

The price of commercial property insurance has risen so dramatically in the last two years that it has reached a crisis point, say real estate players, who are calling for lending reform and government support to alleviate the pressure it is putting on the market.

“Something's got to give or it's just going to paralyze the industry,” said Kevin Keane, the chief operating officer at Bainbridge Cos., an owner, developer and manager of apartment communities that run from Maryland south down to Florida, west to Texas and into Tennessee. “We’ve actually lost out on a number of acquisition opportunities and development opportunities, simply because the insurance premiums have been so high."

Premiums for commercial insurance at the end of 2022 increased an average 9.4% across the country from a year earlier, according to the Insurance Information Institute. In places like Texas, Florida and California, however, the increases are far sharper, with jumps of 30% to 50%, according to the institute.

Construction price increases have pushed replacement costs 40% higher than they were four years ago, III Communications Director Mark Friedlander told Bisnow, and when combined with more frequent catastrophic weather events, it has created an upward spiraling effect for insurers.

In interviews, developers, owners and brokers said the price of insurance is now “out of control" and they are seeking government intervention and asking lenders to adapt their insurance requirements. Companies themselves should reconfigure how they approach deals, too, and bring insurance front and center in the acquisition process, they said.

Though insurance prices have been rising for years, when Hurricane Ian hit Florida in September — killing 147 people and causing a state record of $112B in damage — it was something of an inflection point, said Danielle Lombardo, the chair of Lockton Global's real estate practice.

“We were already predicting very large increases, and post-Ian it just got to a point where it was unsustainable,” she said.

Globally, catastrophes are hitting insurers hard. Last year marked the second year in a row where insured losses around the world from natural disasters were over $100B, according to Insurance Business Mag, citing Swiss Re data. Overall, these disasters pushed worldwide economic losses of more than $275B, driven largely by major events like Hurricane Ian and flooding in Australia and South Africa. Of that, some $125B were insured losses.

For the last 30 years, increases have been going up 5%-7% annually, according to Swiss Re. And for those faced with these price hikes now, the new reality is impossible to ignore.

Take, for example, a recent deal of Bainbridge’s in Florida. Last month, the company was close to acquiring a 400-unit apartment building in Tampa, Keane said, and had budgeted $2K insurance per unit. But the price came back at $2,700 per unit, shaving $5.5M off Bainbridge's offering price. The deal fell apart.

"It really is just out of control now — our insurance premiums across our portfolio have gone up 50% and many of our competitors have gone up 100%," he said. "It’s very painful."

Making matters worse, he said, is the fact a reliable quote often doesn't come in until the final moments of the bidding process. And that's before taking into account the Federal Reserve went on one of the most aggressive interest-rate-hiking campaigns in its history in the last 12 months.

Mario Kilifarski, senior director of asset management at Fundamental Advisors, described the insurance market as having been already volatile and now “shoved right off the cliff."

He pointed to a property his firm is working on in Corpus Christi, Texas, 5 miles from the coast of the Gulf of Mexico, which had its premium go from around $700K to $3.6M. He said a complicating factor is "onerous" lender requirements, including requiring $42M of coverage for wind damage.

“So we're talking 5x increases, which is clearly not sustainable,” he said. “You're starting to have to have some uncomfortable conversations not only just with lenders but also with your partners, [asking] ‘How do we prioritize these payments?'" 

A sticking point multiple industry insiders pointed out to Bisnow was lenders' requirements for how much insurance a property has — almost all require it to be covered to 100% of its replacement cost.

But Lombardo, who develops real estate insurance programs, said those requirements are not aligned with the marketplace today. A solution would be for real estate companies to take on more risk themselves with their insurance, lower their limits and increasing deductibles — but lenders typically demand high limits as part of the loan covenants. 

"We are at inflection point at real estate and insurance," she said. "We have to look at purchasing insurance in a different way."

Keane said lenders should have to adapt their insurance demands. If they are only in for 60% of the property, he said they should not have to force an owner to purchase insurance for 100% of the property.

"The cost of the insurance right now has put many, many projects into technical default because these owners and borrowers can't maintain the debt covenants that are inside their loan documents," he said. "It may well be that they need to have a 25% margin between the earnings of a project above the debt service of a project, and the insurance has eaten into that so badly, they can't maintain that margin." 

Keane suggested that state governments set up something for multifamily owners similar to Florida's Citizens Property Insurance Corp., the state-run insurer created to support homeowners as private homeowners insurance has spiraled into crisis. 

"The fact of the matter is, we're building homes too, the difference is we rent them," he said, calling for government-sponsored property insurance akin to the Affordable Care Act marketplace for healthcare coverage. "Otherwise, we have to increase rents to the point where many residents can't afford to live in our apartments anymore."

Providers have stopped offering policies altogether in states like Florida and California in the last few years at an increasing pace as they determine they can no longer profit from selling property insurance. About a dozen firms that provide homeowners insurance in Florida became insolvent in the two years leading up to Hurricane Ian, The Washington Post reported. In February, another was placed into receivership by state regulators.

Phil Corrigan, the president of commercial insurance provider A.L. Carr Agency, said the shrinking insurance marketplace could necessitate an intervention.

“I have very little faith in government level, doing a thing until they're forced to, but the reality of this is, people are going to start to think in terms of very, very high deductibles,” he said. “It [only] gets attention when the FEMA flood insurance program suddenly says 'You're not covered for this, you're not covered for that,' people go berserk and get scared.”

Lombardo said the current insurance situation necessitates an industry-wide rethink on the way real estate companies should do business.

To begin with, investors need to “get granular” with insurers and their lender requirements to see where they can reduce their limits and in which areas. Specifically, she said these companies need to look at buying insurance differently — and that means taking on more risk themselves.

"The way that you do that is wildly different than how real estate owners have purchased insurance in the past," she said. "It's less transactional."

Importantly, she expects buyers approaching a seller will need to focus on insurance costs as a critical part of the equation for any acquisition, rather than as an afterthought as it has long been in most commercial real estate deals.

"Psychologically, it's very difficult because the deal teams are like ‘I don't want to deal with insurance,'" she said. "It's a much more methodical, thoughtful approach that most real estate clients haven't had to take in the past, and that move from that type of mindset to really what's needed in order to set you up for success in today's market is a huge shift."