Commercial property owners, already struggling with high interest rates and rising vacancies, face exploding insurance costs that keep hitting new highs.

Natural disasters, inflation and a shrinking reinsurance market have pushed insurance
premiums to record levels, echoing the surge in home insurance rates for much of the U.S. That leaves many landlords in a bind. Their building values and rental income are down, yet expenses keep rising.

Commercial real-estate insurance costs have risen 7.6% annually on average since 2017, according to Moody’s Analytics. Those increases can result in hundreds of thousands of dollars or more in additional annual costs, depending on location and size of the property. They can be steep enough to wipe away a year’s worth of profits.

While insurance premiums are rising virtually everywhere and for all building types, some cities have been particularly hard hit, especially for multifamily buildings. Costs to insure rental-apartment buildings rose 14.4% annually on average in Dallas, 13% in Los Angeles and 12.6% in Houston. Some owners struggle to find anyone willing to insure their buildings,
Moody’s said.

“I have never seen such a significant and rapid change in insurance capacity as well as spikes in pricing,” said Alexandra Glickman, leader of the real estate and hospitality practice at insurance consulting firm Gallagher.

For some property owners, the impact of rising insurance costs has been more punishing than rising interest rates. Many landlords still have low debt costs because they signed long-term, fixed-rate mortgages before 2022 that don’t expire for years to come. But insurance contracts typically renew every year. That means virtually every property owner has been forced to either sign a new policy at a higher cost, or skip insurance altogether.

The number of property sales for $25 million or more is down 79% since late 2021, according to CoStar Group. Rising insurance costs are contributing to that steep drop. “Deals that may have just fit what we are buying are now off the table because the insurance costs are just too high,” said Ian Bel, managing member of apartment landlord Olive Tree

Bel said he hired risk-modeling companies to calculate the likelihood of losses and is talking to lenders to get them to accept insurance with a higher deductible. That would keep down annual costs, but also leaves the company partly on the hook if disaster strikes. Intensifying natural disasters are a big reason for the increase, particularly in cities vulnerable to wildfires, floods or storms. The cost of reinsurance has also increased, trickling down to higher property insurance rates. Meanwhile, inflation has pushed up the cost of repairing or rebuilding damaged properties. In some cases insurers choose to not even
provide quotes, leaving those who do free to charge higher premiums.

Owners of rental apartment buildings are particularly vulnerable because they have to pay for insurance. Commercial landlords can typically pass the costs on to their tenants, said Robert Gilman, a partner at accounting and advisory firm Anchin. But that is only helpful if they have tenants. Rising office and retail vacancies mean many property owners are left to foot much of the bill themselves.

Mortgage lenders typically demand that owners get insurance that covers the full cost of rebuilding the property, Glickman said. Some owners are now trying to lower that amount, arguing that it is unlikely the entire building will be destroyed. Landlords and insurance brokers say banks are often open to the idea, especially in cases where rising costs threaten a

Some banks are still insisting on full coverage. Until May 2023, real estate owner Three Pillars Capital Group paid $630,474 annually to insure the 544-unit Del Mar Apartments complex in Houston. But when the insurance expired and Three Pillars requested quotes for a new one, the estimated cost tripled to around $1.8 million, the company said in a court filing.

Three Pillars said it tried to get its mortgage lender, Bancorp Bank, to agree to a lower coverage. Instead, it said, the lender forced it to accept a policy costing around $2.3 million a year.

Because of the spike in insurance payments, the building’s revenues are no longer enough to cover expenses and debt payments, said Three Pillars Chief Executive Gautam Goyal. Earlier this month, Three Pillars took the unusual step of suing its lender for breach of contract and breach of fiduciary duty, alleging that Bancorp forced it to take out unnecessary
and excessively expensive insurance.

Bancorp didn’t respond to requests for comment.

This article was written by Konrad Putzier, WSJ

Appeared in the September 27, 2023, print edition as ‘Surging Insurance Costs Squeeze Office Landlords’.