Insurance- The Elephant in the Room

Insurance costs in some areas of Texas, California and Florida are up 50% to 100% year-over-year. There has also been a slew of destructive tornados across a dozen states recently, so it won't be long until insurance rates rise there as well. Insurance is always one of the biggest expense items in a commercial real estate budget but with the recent increases, getting it wrong can be the difference between a winning deal and a big loser. We recently reported multi-family deal closings fell 74% in Q1 2023 and rising insurance costs are one of the big drivers. Many sellers price their deals at cap rates that don't account for rising insurance and interest costs, so the bid/offer gap is too wide to get deals done.?

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Buyers are required by lenders in most cases to have 100% replacement cost for insurance. The reality is that in most cases, storm damage doesn't result in a complete loss, so owners feel that they are being forced to carry insurance above what they really need. The industry needs the banks to work with buyers to soften covenants and reduce the cost of excess insurance. CRE industry groups are also petitioning the government for a solution to this problem. At the end of the day, renters end up paying for all the increases in expenses, which only makes rent more unaffordable for the average person, so it is in the public's interest to keep costs down.?

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For some owners the rising cost of insurance potentially could be, "the straw that broke the camel's back." Many properties in Florida and Texas were purchased during the pandemic at very low cap rates. It is not uncommon for insurance to run at 10% of rental income. A 50% increase could move insurance to 15% of income and basically wipe out the cash flow from the property. For owners who also have variable rate financing, it's a double whammy. Insurance costs are adding stress to an already stressed market.?

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We are putting insurance contingencies into our offers to ensure that our projections reflect what we can expect to pay. We believe the government will step in at some point and help stabilize and reduce insurance costs to lower the pressure on rising rents. In the meantime, we are forecasting much higher rates and pricing our deals accordingly.