Commercial property insurance costs have skyrocketed and are expected to rise further in the U.S. over the next few years. These skyrocketing costs can slow the sales process and even cause transactions to be modified or abandoned.
The average cost of insurance for commercial property in the U.S. has nearly doubled over the past decade, according to an analysis released in late May by the Deloitte Center for Financial Services.
In its 2024 Financial Services Forecast report, the company notes that insurance costs averaged $1,558 per building per month in 2013. By the end of 2023, that figure will rise to $2,726, a compound annual growth rate of 5.75%. By 2030, Deloitte projects that average monthly insurance costs will rise to $4,890 per building, accelerating to a compound annual growth rate of 8.7%.
Tim Coy, real estate research leader at Deloitte, told PERE that while the overall rise in costs isn't surprising, he and his colleagues were surprised by the pace of the increases over the past few years.[Costs] “Over the last five years, we've seen increases of over 100% in certain markets, which exceeded our expectations,” he says.
While inflation and COVID-19 played big roles, Deloitte said it applied an extreme weather model to its price projections out to 2030 and found that cost spikes were about 98% correlated with extreme weather projections.
Property owners are facing mounting costs as devastating weather events become more frequent. Last year, the United States experienced a record 28 billion-dollar weather and climate disasters, and devastating weather events continue to occur in 2024. As of mid-June, there had already been 11 billion-dollar disasters across the United States, most of which were severe thunderstorms.
Deal-killer
The rising cost of insurance is now having a direct impact on private real estate transactions. “Typically CEOs don't want to get involved in the minutiae of insurance, but they have to because it kills the deal,” says Daniel Lombard, managing director of real estate, hospitality and leisure at insurance services provider WTW. He notes that while premiums have stabilized in recent months, they are still at all-time highs in some parts of the US, such as Texas and Florida. Insurance costs remain unpredictable, impacting property owners' ability to reliably underwrite insurance.
“That volatility is exactly what managers need to focus on, because if you're halfway through a deal and you're trying to close and a big hurricane comes along, you're not going to get the coverage you thought you were getting,” she says. “You'll lose all cash flow from the deal and it won't make sense.”
Lauren Hochfelder, co-CEO of Morgan Stanley Real Estate Investing, said the impact of rising insurance costs on the market has intensified over the past 24 months. “Over the past two years, the market has seen a number of asset sales fall apart due to rising and variable insurance costs,” she told PERE.
Additionally, Hochfelder said, the cost of insurance further slows down the sales process, especially for multifamily properties. “For example, a residential building in Florida had 15 bidders, each with completely different underwriting rates for insurance costs per unit,” she said.
“[It] Assuming $800 per door, that has a huge impact on value. [in insurance costs] “Insurance costs affect NOI, and if buyers have different views on what insurance they need, it also affects what they're willing to pay. As a result, transactions are taking longer to close.”
Hochfelder added that rising insurance costs have made net lease investments more attractive to his company, which he explains is relatively safe because it transfers some of the risk from the lessor to the lessee, at least for the initial lease term.
Joe Golin, head of U.S. and European investments at asset management firm Barings, said his firm and others pulled out of the bidding process because of premium rates.
“There are numerous examples of transactions that have dragged on, fallen apart or been repriced because buyers made incorrect assumptions or didn't finalize insurance until after they had acquired the property,” he says.
“We have withdrawn from bidding in cases where we believe others have undervalued the cost of insurance below what we consider to be reasonable. We set very high standards for insurance and want to ensure we have appropriate levels of cover to satisfy the institutional investors and banks we work with.”
Golin added that with insurance costs now impacting valuations more than they have in the past five to 10 years, the company will be “very careful” in selecting deals. With concerns about coastal erosion and flooding, this may mean taking a closer look at the flood history of certain areas and considering whether a property is close to the coast. “Have I ever boldly declared, 'I'll never buy in Florida'? No. But every investment will be looked at with a long-term view of, 'Is there going to be capital in this region in the next five to 20 years?'”
Price adjustment
But while managers tell PERE they're not avoiding certain parts of the country just yet, they are paying less for properties in higher-risk areas.
“If there's higher risk, they're factoring that into higher premiums and underwriting,” says Pete Petron, investment manager at Virginia-based asset manager Harbor Group International. “So if the property has higher premiums, that's reflected in the purchase price.” Rising insurance costs lower underwritten NOI, meaning less money has to be paid to meet target return requirements.
As costs rise unpredictably, insurance will increasingly influence the type of property buyers want to acquire, the speed at which they transact, and the price they are willing to pay.