Since about 2018, property insurance costs marched steadily upward, almost universally, in commercial real estate, broadly forcing property owners and lenders to strategically confront the reality of soaring premiums and shrinking availability. But much of the industry has also enjoyed significant rent growth, which seemingly has muted the overall impact to bottom-line revenues and property values.
The impact is barbelled, however. For a segment of properties, insurance now eats up double the typical share of revenue—a major caveat emptor for buyers and lenders that puts insurance and physical risks much higher on the standard due diligence checklist. For asset managers, this throws many things out of whack, affecting budgeting and exit strategies, and, in some cases, forcing owners to ask lenders to waive requirements for minimum coverage.
Impact by the numbers
Figure 1 shows the results of analyzing insurance costs as a share of gross revenue since 2018 for properties backing CMBS loans. For the properties below the 50th percentile, relatively little changes. For properties with the highest share of revenue taken by insurance, however, this value jumps from 6.7 percent in 2018 to 13.4 percent in 2023.
All else being equal, that means a property would need an additional 1.3 percent annual rent growth to maintain net operating income (NOI) and value. Otherwise, a typical 99th-percentile property in Figure 1 could experience roughly a 12 percent decline in NOI and value, and its lender could have the implied loan-to-value ratio go up 9 percentage points and the debt-service coverage ratio (DSCR) go down 0.25x. Of course, the higher the expense ratio of the property, the worse the impact.
Where the hits are hardest
Geographically, there was some slight skew of impact to the Gulf Coast. Texas and Florida are the only two states that have multiple metros in the top 20 metros with the most properties in the worst quintile for 2023—four and five, respectively. Other such top metros are scattered throughout the country—particularly in the East, Midwest, and South—indicating insurance pains are not limited to the Gulf.
Among property sectors, multifamily and retail suffered the worst impact, followed closely by hotel and office, whereas industrial felt the least impact. Hotel tends to have higher expense ratios, so these insurance premium increases can mean significantly more to NOI and value declines, particularly alongside other pressures, such as declining business travel and higher labor costs.
Finally, industrial properties were the least affected—possibly due to strong rent growth, being less likely to locate near coastlines, and lower replacement costs.
