You Don’t Need A Weatherman To Know Which Way Insurance Rates Are Going
Perhaps one of the most significant sources of increased costs to consider when developing or managing CRE property, behind the dramatic increase in construction costs, is an equally imposing uptick in insurance rates. What’s causing those increases?
Xander Snyder, the Senior Commercial Real Estate Economist for First American Financial Corporation (a provider of title, settlement, and risk solutions for real estate transactions), offers these key points in his blog entitled, “What’s Behind the Increase in CRE Property Insurance Premiums?”
- Commercial property insurance premiums have significantly increased over the past five years, driven by factors such as increased weather-related damages, rising replacement costs, and reinsurance unavailability;
- The increase in insurance premiums varies by location, with properties in disaster-prone areas experiencing the highest increases; and
- Large institutional operators can negotiate better insurance rates, while smaller operators, especially in high-risk areas, face greater financial strain due to rising premiums.
SIORs certainly agree with those findings, while also pointing out that risky tenants, environmental concerns around the property, construction materials selected, maintenance practices and regular inspections can all impact premium levels over time. And, they add, it’s critical to get advice from professional experts like insurance agents.
“Primarily, it’s climate change—no question,” asserts Ted Konigsberg, SIOR, president of Infinity Commercial Real Estate in Miami. “Just look at what’s going on in terms of dollars and cents, and the number of events.” In Florida, he notes, the cost of commercial property coverage per square footage used to be counted in cents; now, it’s counted in dollars.
“Here in Florida where I am, we’re used to hurricanes, but the frequency and intensity have been increasing,” he continues. “Most major reinsurance companies, including Berkshire Hathaway, won’t reinsure in Florida; the state had to set up its own agency.”
Arlon Brown, SIOR, director-brokerage, commercial real estate advisor with NAI/Parsons Commercial Group in Boston, agrees, adding that severe weather includes more than hurricanes and tornadoes, “All these catastrophes, including the fires out West, affect everyone,” he observes.
If you’re the broker in a transaction you should make sure that you tell your client the buyer they need do an environmental inspection.
Location, Location, Location
Konigsberg notes that where your property is located is also a significant risk factor when it comes to severe weather but cautions SIORs that areas which used to be considered “safe” may not be so anymore. For example, he points out, AccuWeather predicts 1,300-1,450 tornadoes in 2025 and identifies the Mississippi and Tennessee valleys as the areas of highest risk. “But that’s not traditionally where the heaviest impact was—it was Texas, Oklahoma and Kansas,” he points out.
Konigsberg relates a recent event that underscores his point. “I work the ‘Treasure Coast;’ just above Palm Beach County,” he shares. “In the area west of I-95 and the Florida Turnpike they really didn’t worry about hurricanes.” A few months ago, he continues, a tornado came through, and one of the properties hit was a brand new one million square foot industrial building. The building, he adds, was tilt-up concrete and up to current windstorm code. “The tornado ripped most of the roof off the building,” he recalls. The steel was so stressed, he says, they had to tear the building down. “If someone had told me just five years ago a building built to those standards would be destroyed, I would have called them insane,” he declares. But five years ago, he shares, the area was sparsely developed, “So companies that insured in that area would have had no loss.”
But does that mean SIORs and their clients are purely at the whim of where Mother Nature chooses to deliver her wrath? Not at all, says Konigsberg. “Typically, owner-occupiers look at available infrastructure; they look at proximity to labor markets. Do they look at geography and geology? They are now,” he says. “Is it located in a flood zone or not? Is there a wind corridor? If you have two mountains next to each other and a valley below you know where the wind is channeled. Look at the history of the area –it even goes down to looking at your neighbors, and things like vegetation. Are you located next to vegetation and forest? No, I don’t think so!”
And that’s just the beginning. “It’s all about risk,” says Konigsberg. “Be sure, out of common sense—and a lower premium—to maintain the building.” For example, he says, prior to hurricane season, or if you’re in an area subject to other water-type events like floods, “You need to caulk any cracks—PERIOD; your windows, and anything that goes through the wall of the building. Make sure the weather stripping will seal the door in a flood situation. Maintain the roof—which means the areas where A/C units are mounted, ventilating fans, and pitch pans.” If the area is prone to fire, he continues, look at your landscaping and make sure it’s not too close to your building, and that the vegetation is trimmed. “Will branches of trees fly off into your windows, or are they trimmed properly?” He challenges. “If the building is old, do things like putting in hurricane-proof windows.”
Brown adds that with older buildings, especially industrial facilities, common sense should rule the day. “The insurance companies like to stay away from wooden-frame buildings like old mills, or ones that do not have a sprinkler system,” he says. In fact, he adds, you may even want to consider putting in a sprinkler system after calculating the payoff; how many years of lower premiums would enable you to “earn” it?
Watch Those Tenants
Brown notes that one of the other major sources of higher insurance costs—but happily, one you can do a lot about—involves the tenants or owner-occupants themselves. “Know what industry they’re in—are they good managers of their own operation?” he poses. “It doesn’t matter if they work with widgets or chemicals; do they have proper disposal and adhere to all the rules and regulations?”
That even extends to your neighbors, adds Konigsberg, when the issue of environmental indemnity might be at play. “What’s next to you? What do they do for a living?” he asks. “Are there any known sources of pollution around you? Environmental insurance may be impossible, or very expensive to get. Look at all those things when you look at a location.”
How can you identify high-risk tenants or neighbors before they go into your building? “With the Internet today, every company has a website,” notes Brown. “With new tenants, especially in industrial buildings, you need to look at what they are actually doing. Also, look at their industry. Find out if they are required to have any special permits. How do they store anything that is potentially hazardous?”
He recalls the first big deal he ever did, where someone in the parking lot had changed their oil and took the old oil and dropped it on the asphalt. “We said we’d pay for the cleanup, although $25,000 wound up being $100,000,” he shares. You always need to be aware if you do have a tenant with serious environmental issues; then, it’s probably best to spend the money and do an environmental test of the ground before entering the building, so you have a record of what’s going on.
In fact, he adds, “If you’re the broker in a transaction you should make sure that you tell your client the buyer they need do an environmental inspection. A lot of times, because it’s cheap, they will just do a physical inspection. Also, get a report at the fire station and ask if there are any problems they know about.”
“Have you gone to their existing location? Too busy? Big mistake!” says Konigsberg. “You need to do that before you sign the lease. Look for improperly stored hazardous materials—hydraulic fluid, oil, gas, solvents. Are they in containers or drums in the middle of the floor?” He also recommends a general housekeeping check for safety equipment, maps for the fire department, MSD sheets and so on. “A spill can bankrupt you,” he warns.
Brown shares his concerns. “What do companies have in place for containing hazardous materials, or anything that could be combustible? Are they really concerned about that, and do they have a loss prevention manager, a good track record?” he queries. “With the state, you can look up their records to see if there have been a lot of workman’s compensation cases; that’s a prudent way of investigating.”
What’s In The Lease?
You can do a lot to mitigate insurance risks by structuring your lease carefully, Konigsberg advises. “Contemplate all eventualities,” he says. For example, he points out, the landlord has the right to declare default for unsafe conditions. The lease should also say the tenant has to provide annual certification of insurance and 30 days’ notice of cancellation. “Tenants can’t be allowed to go uninsured, period, and you deserve notification,” he says. “All these things come down to: a) The landlord should make sure the lease contemplates all potential liabilities and remedies; and b) Manage your property. Just because the tenant pays rent does not mean you should not walk through a couple of times a year and be 100% sure the insurance is current.”
When he represents tenants, Konigsberg says he looks for landlords with multiple properties. “They have a blanket policy; the big boys do not insure each building individually,” he explains. “The larger landlord—like a national industrial REIT—is going to own properties across the country—hurricane, flood, tornado zones—which mitigates risk to insurance companies.” The risk is not only spread, he continues, but larger owners have greater negotiating power. “You also have to pay attention on the tenant side—ask for insurance costs, ask for history, and be very, very careful about individual landlords,” he advises.
No matter which side you’re on, he adds, you to need pay attention to subrogation clauses—the process where an insurance company, after paying a claim, has the right to seek reimbursement from the other side. “The tenant does not want that in the lease, or they’re barred from going after the landlord’s insurance — and it’s the same on the landlord’s side.” In any case, he says, you “100%” need advice from a good attorney and a good insurance agent. (For more on using outside professionals, see the section below.)
The value of an SIOR, in effect, comes down to being able to advise—that is what we do.
It Takes A Team
SIORs are excellent advisors, but as both Brown and Konigsberg note, they are not experts in insurance or law. Therefore, they say, with matters as important and as potentially costly as insurance you need a team that includes outside experts to provide your clients with the best possible protection.
“The whole thing is you really need a team to be involved—including insurance agents,” says Brown. “One of the biggest issues is if a developer/investor builds low-risk offices, it’s not good to put industrial properties on the same policy. You need a good insurance agent, because different insurance companies will have different tolerance policies.”
And how do you find a good agent? “One, by word of mouth—other professionals like attorneys and accountants,” he says. “Many times, it’s personal relationships—for example, I went to school with an agent for one of largest insurance agencies in New England; he can speak very frankly with me.”
Konigsberg agrees. “Owners are not experts, and they’re really not sure who turn to,” he says. “I recommend to both sides of the fence an independent insurance agent you trust. You can bid your coverage out to several different companies, who will sit down with you and go over the pros and cons on all policies, and ratings of insurance companies.”
You need a good real estate attorney and a good insurance agent,” Konigsberg continues. “Before you sign a lease, the agent—more than the attorney—should review the lease for coverages you’re required to have, indemnity and liability clauses, the environmental side of it, and if I’m representing a tenant I want them to make sure it’s an ‘as clean as day’ commercial lease and the tenant is liable only for what they do to themselves, not for things like leaching from another property. Of course, the landlord wants the opposite—but they don’t get it.” The bottom line here, he points out, is that every property, and every tenant, is unique, and requires that professional expertise. “One lease for all tenants? You just can’t do that,” he asserts.
You will also want your agent to perform an annual audit, he adds. “Most of them will give you an engineer of some sort to come out and do one,” says Konigsberg. Very often, he notes, insurance companies will require one, “but why wouldn’t you want to get ahead and correct any deficiencies?”
SIORs, Konigsberg points out, tend to focus on building and liability insurance, but there are other types that are important. “Many years ago, I was taught a lesson about the value of a good agent and a property audit,” he shares. He was representing a furniture manufacturing company that had a frame shop, saws, and drills (which could easily cut off a limb during an accident.) “Since they made upholstery, they also had springers, cutters, and upholstery people,” says Konigsberg. “The manager set things up in what was for him the most logical, efficient way. Springers happened to be in the frame department; they were classified the same way as people in the wood shop (where the drills are used). By painting a red line around them they were reclassified; this saved the tenant thousands of dollars a year. Again, you can’t do these things yourself.”
Which brings him to the value of an SIOR. “The value of an SIOR, in effect, comes down to being able to advise—that is what we do,” says Konigsberg. “We have a wealth of knowledge and experience. What we can do is advise our clients, no matter which side of the fence they’re on. It is the value of our contacts. Advising someone to do something like insurance requires that other professionals get involved—insurance auditors, agents, engineers. We are the sources of those valuable professionals.”
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