Lenders Have Leverage With Insurance Costs
They could make or break NOI and the financial viability of a property.
Insurance, who needs it? Any CRE property if it wants financing. But disasters are making that costlier than ever before, as GlobeSt.com has reported.
Commercial property insurance premiums were up 20.4% in the first quarter of 2023 — the first over-20% jump since 2001. Many markets have seen double-digit premium jumps. Some policy renewals offer half the coverage for the same price as before. The lack of affordable options is putting needed levels of coverage out of the reach of many owners. And it’s also putting a lot of potential power in the hands of lenders.
A Marcus & Millichap special report on natural disasters and insurance risk focused on how weather events can reshape the CRE investment landscape. “Hurricane Idalia was this year’s 16th extreme weather event with more than $1 billion in property damages,” the firm said. “The pace set so far in 2023 has already nearly matched the trailing three-year average of 20 events, which in itself is up from a mean of 12.8 in the 2010s.”
Storms, wildfires, and other events are also becoming more geographically dispersed, hitting not only the southeast but also California, Washington State, Oklahoma, and Oregon. “Even if insurance covers the cost of repairs to damaged properties, investors are still impacted by interrupted cash flows and other logistical hurdles,” the firm wrote. “At the same time, to cover the frequency and cost of weather events, insurers are having to raise premiums for properties, which in turn impacts investors’ decision-making.”
The Wall Street Journal mentioned a 7.6% annual increase in average CRE insurance costs since 2017, so not something to be blamed on the pandemic. Depending on the property type and location, the reality can be sharper, with coastal locations the steepest, as might be expected given weather patterns.
Insurance increases are also something that can’t be avoided. Even if a property owner managed longer-term financing at lower rates, the premium hikes can be inescapable. And for new properties, forget it. “Deals that may have just fit what we are buying are now off the table because the insurance costs are just too high,” Ian Bel, managing member of apartment landlord Olive Tree Holdings, told the Journal.
There’s been scant attention to the role lenders can play. Typically, they will require full coverage, but that typically is their decision, unless outside sources of capital have the requirement.
The higher the operating costs, the lower the debt service coverage ratio and net operating income, making borrowers riskier. A change in lender requirements could make a lot of financial plans sounder.
Then again, with the reluctance many lenders, particularly banks, have shown to providing financing, insurance could become another tool to slow lending. Keep the demands high so that a deal can’t pencil, and a would-be buyer can’t cross the sending standard hurdle. The two extremes show how lenders have far more control over effective insurance rates than has generally been considered.