Commercial Spotlight | Buyers Must add Insurability to CRE Due Diligence List
Natural disasters are becoming more prevalent, and we have all heard about how difficult it is for property owners on the coasts to get insurance for their properties. This is especially true in areas prone to hurricanes, such as Florida, and areas with earthquakes, fires, and tidal events, as experienced in California. Insurance costs have skyrocketed and in many cases property owners are faced with either being unable to obtain insurance or paying rates that are so high it is not feasible to insure the property. The rise in natural disasters has not spared the mid-west and we’ve seen local rates double in the past 5 years and they are expected to double again in the next 5-10 years.
Even though Traverse City has not experienced catastrophic disasters, we have experienced insurance companies refusing to insure local buildings due to the age of the building or conditions in the building, such as the age of the electrical system or roof. Insurance companies are using historical aerial photos to look at roofs and if they see discoloration over time, the possibility of bad drainage is enough to have coverage denied. Those who can afford to go without insurance may self-insure, but for anyone getting a bank mortgage, lack of insurability is going to be a deal breaker. Banks require buyers to insure their property, in order to secure the bank’s investment.
In the Commercial Real Estate world, financing and leverage are aspects that help create higher returns, and when financing is not available, buyers shy away from those properties. Due to the difficulty of obtaining insurance, and therefore financing, finding out about the insurability of a building has become one of the first due diligence items that prospective buyers should be pursuing. In the past, insurance was just a line item in the expense report and not something that was driving the feasibility of a purchase.
One of the primary factors contributing to rising insurance rates in the Midwest is the heightened frequency and severity of natural disasters. While the region may not experience hurricanes or coastal flooding, it is particularly susceptible to tornadoes, hailstorms, and severe thunderstorms. According to data from the National Oceanic and Atmospheric Administration (NOAA), the Midwest has witnessed an increase in billion-dollar weather events in recent years. These catastrophic occurrences result in significant property damage and lead insurers to raise premiums to cover losses. Additionally, flooding has become a growing concern in parts of the Midwest due to heavier rainfall and outdated drainage infrastructure. Flood damage can be particularly devastating for commercial properties, which often house valuable equipment and inventory. As insurers face mounting claims, they adjust their pricing models to reflect the heightened risk, driving up insurance rates.
Another factor leading to higher rates is the increasing cost of construction and property repairs. Tariffs, supply chain disruptions, labor shortages, and rising material prices have all contributed to higher rebuilding expenses. When insurers calculate premiums, they consider the replacement cost of a building in the event of a loss. Inflation also increases administrative and operational costs for insurance companies, which are then reflected in elevated premiums.
The rise in insurance rates has significant implications for the commercial real estate market. Property owners and investors are faced with higher operational expenses, which can erode profit margins and lead to decreased property valuations. There may be some strategies that developers can employ to manage rising insurance costs such as strengthening building materials, installing storm-resistant windows, elevating mechanical systems, and investing in flood mitigation efforts such as proper drainage systems. For existing buildings, negotiating with insurers and seeking competitive quotes from multiple providers can also help in securing the most favorable rates. Partnering with risk management consultants to conduct assessments of properties can also be an avenue for reducing risk. In the example of the discolored roof, the insurance company was willing to reconsider the denial if the insured provided a comprehensive roof inspection report.
The rising insurance rates in our area and the whole nation present a formidable challenge for commercial real estate investors. Driven by the increased frequency of extreme weather events, rising construction costs, and economic inflation, these escalating premiums are impacting property values, operating expenses, and investment decisions. By including insurance quotes early in the due diligence process of evaluating a purchase, the buyer can make an informed decision on the risk of the investment and have time to implement strategies to lower insurance costs and safeguard their investments.
Dan Stiebel, CCIM
