By Emily Flitter
Following the pandemic, rising vacancy rates and climbing debt obligations have negatively impacted commercial real estate for over two years. As these immediate issues begin to ease, owners of strip malls, residential complexes, and office buildings now confront a longer-lasting challenge: escalating insurance expenses.
This dilemma is well-known among homeowners nationwide. An increase in climate-driven natural disasters has led insurance firms to substantially hike rates or withdraw from certain markets. The most significant rate hikes are occurring in coastal regions susceptible to severe storms or flooding, but insurers and financial institutions are acknowledging that no location is completely insulated from increasingly extreme and unpredictable weather phenomena.
Insurers may face liabilities of up to $75 billion due to damages from Hurricane Helene, which caused devastating floods and landslides across Florida, Georgia, and the Carolinas last month, as well as from Hurricane Milton, which struck near Tampa less than two weeks later.
Property owners find themselves caught between their insurers and lenders, who are wary of potential catastrophic liabilities and resist even modest adjustments to policies — even those adjustments that might provide some relief to a struggling borrower.
While it’s difficult to accurately quantify how many properties have entered foreclosure solely due to rising insurance costs, industry insiders report awareness of transactions that have collapsed over these issues. Developers and investors indicate that in an environment grappling with rising interest rates alongside increased materials and labor costs, insurance expenditures can be a decisive factor.
“The current interest-rate climate has revealed who is knowledgeable and who is not,” remarked Mario Kilifarski, head of asset management at Fundamental Advisors, a New York investment firm managing $3.5 billion in assets.
Insurance brokerage Marsh McLennan estimated that commercial property premiums increased by an average of 11% nationwide last year, but some regions, particularly those prone to storms like the Gulf Coast and California, saw rises of up to 50%. This year, premiums in certain areas may have even doubled, according to the brokerage.
For apartment complexes, insurance expenses now represent 8% of operational costs, a figure that has doubled compared to approximately five years ago, stated Paul Fiorilla, director of research at Yardi Matrix, a data analytics firm. Although insurance still occupies a minor portion of total expenses like taxes and maintenance, Fiorilla noted that it contributes to the overall pressure from stagnant rental income and increased borrowing fees. Landlords experienced a faster growth rate in operating costs last year compared to their revenue, he added.
Lenders are becoming increasingly anxious.
“We receive constant inquiries from our banks,” stated Kevin Kaseff, a co-founder and managing partner of Titan Real Estate Investment Group, a California company focused on senior living facilities and cold storage buildings for produce destined for grocery stores.
The lenders have sought clarification on how he is acquiring insurance, Kaseff explained, especially concerning properties in California, where some insurers have ceased new business operations.
“They’re uneasy,” he added, expressing frustration that even though lenders are keen to discuss his recent initiatives, they show no readiness to assist.
Like homeowners, commercial property owners are mandated by banks to maintain insurance policies if they hold a mortgage. However, the stipulations can be more stringent: A commercial real estate borrower typically requires explicit consent from their lender to modify insurance coverage, and if the loan has been securitized and sold to Wall Street investors, obtaining that consent can prove impossible.
Lenders have largely been reluctant to ease insurance requirements due to concerns about the broader implications for the property market. If a significant catastrophe results in the destruction of a building, what will happen if reconstruction becomes unaffordable?
“Insurance pricing has led to deals being stalled and in some cases forced into foreclosure,” remarked Danielle Lombardo, chair of the real estate, hospitality, and leisure division at Willis Towers Watson, an insurance brokerage. She noted that part of the challenge is that costs can escalate from the time a buyer begins seeking financing until the moment the transaction is ready to close.
To Kaseff, the solution appears straightforward. Banks should permit commercial real estate owners to purchase insurance with higher deductibles to reduce coverage costs. Alternatively, they should approve policies that cover only the loan amount rather than the full cost of replacing a building if it is lost.
However, banks may be reluctant to shift their stance because if landlords without comprehensive insurance cannot rebuild after a major disaster, it could destabilize the real estate market, diminishing the value of the banks’ collateral, said Adam DeSanctis, a spokesperson for the Mortgage Bankers Association, a trade organization. Regulators are also monitoring the banks’ responses to ensure they do not inadvertently heighten risks for the financial system.
Analysts contend that the insurance challenge represents more of an inconvenience than an impending disaster, and data on loan delinquencies indicate distress but no significant reason for concern. By exercising extreme caution in their lending and offloading as many older commercial real estate loans from their portfolios as possible, banks may have averted a crisis.
Since the fall of 2022, delinquencies have increased to 1.5% of all outstanding commercial real estate loans, according to Nathan Stovall, director of financial institutions research at S&P Global Market Intelligence. The largest banks are witnessing the most considerable surge in delinquencies, with rates reaching 5%. This figure remains well below the 10% seen during the 2008 global financial crisis.
The decline in commercial real estate is particularly affecting larger banks more severely because their lending encompasses properties — such as skyscrapers in metropolitan areas where office occupancy has not rebounded — that have been most impacted by the shifts in occupancy patterns initiated by the pandemic, Stovall noted.
On September 18, the Federal Reserve lowered its benchmark interest rate by half a percentage point, marking the first reduction since rates surged in 2022 and 2023, with expectations for further cuts this year and the next.
This development is the first piece of positive news for commercial real estate owners in years, but it does not indicate that developers are completely secure. Interest rates remain significantly higher than when many borrowers initially financed their properties (a period largely influenced by the pandemic’s record-low rates). Additionally, securing new loans remains challenging.
