What’s Driving Rising Insurance Costs in Commercial Real Estate in the US?

The State of the CRE Industry

A multitude of complex and interrelated factors are influencing rising insurance costs in the commercial real estate (CRE) industry in the US.

Traditionally, property insurance expenses inflate by about 2–3% per year – a standard target for budgeting for asset managers, underwriters and lenders.

However, in recent years, the year-over-year insurance cost increase has hit over 17% in certain markets, according to Moody’s Analytics’ August 2023 report. Concurrently, to decrease exposure, providers are implementing new policy limitations.

These combined dynamics are wearing down CRE developers’ and owners’ margins, particularly in states with higher environmental risks, including but not limited to Texas, Florida, and California.

For stakeholders to navigate the challenging CRE landscape, it is crucial to understand the key drivers of rising insurance costs.

Increasing Commercial Real Estate Insurance Rates: The Driving Factors

Natural Disasters

Natural disasters such as wildfires, hurricanes, winter storms and tornadoes often cause losses worth billions of dollars. The rising severity and frequency of such disasters, influenced by climate change, are continuing to pose concerns in the CRE industry.

Properties with the highest insurance premiums often have greater estimated damage from natural disasters. According to Moody’s report, hurricane exposure has the most apparent relationship to insurance expense.

For instance, if we consider retail properties in Miami, which is at risk of hurricanes, the cost of insurance spiked by 7.5% between 2017 and 2022, while the rent increased by 1.4% on average. The story was similar in Denver, which is plagued by nearby wildfires; the cost of insurance went up by 9% while the rent increased by 0.4%.

Note that some CRE companies are finding it difficult to buy sufficient insurance at suitable terms. Hence, properties do not have enough insurance to fully cover the damage inflicted by increasingly frequent extreme weather events. In the short term, this further indicates that property lenders and investors have to shoulder certain risks that might have once been covered by insurance.

Inflation Issues

Over the past few years, inflation has been a prevalent issue in the CRE industry. Indeed, according to the US Bureau of Labor Statistics (BLS), the consumer price index (CPI) touched a 40-year high in June 2022. It later reduced in 2023, but remains elevated, thus hiking the cost of some building materials and property repair expenses. Subsequently, insurers have raised premiums to cover these higher potential payouts.

Note that central banks have attempted to reduce inflation by increasing interest rates. However, this in turn has heightened the costs of financing. Altogether, with increased borrowing costs, tightening loan standards, and fewer lenders, CRE buyers might face challenges in deploying capital for purchases this year.

Reinsurance Challenges

To manage potential losses, insurance companies often buy reinsurance. That is, insurance for insurers. However, much like commercial real estate insurance, reinsurance costs have hiked. This has further trickled down and impacted the premiums charged to organizations.

While demand for reinsurance is high, capacity is expected to become more limited in the near future, thus impacting commercial real estate insurance rates.

Furthermore, reinsurers have become more discerning in how much risk they are willing to address. The gap between reinsurance demand and supply has vastly increased in recent years.

Labor Shortages

The last few years have seen widespread labor shortages in CRE. This talent shortage has been identified as one of the largest barriers to success.

According to the Associated General Contractors of America, workforce shortages are particularly severe in construction. Indeed, 66% (two-thirds) of firms reported that their projects had been delayed due to labor shortages.

One of the main reasons cited for these shortages is the lack of relevant qualifications. 77% of firms asserted that candidates lacked the skills required to work in construction or did not pass drug tests.

It’s not just the construction sector; hotel operators are also concerned about balancing quality services with staffing shortages. In 2022, the labor force in hospitality sat at only 84% of pre-pandemic levels, according to Deloitte’s 2024 commercial real estate outlook report.

Such shortages, combined with supply chain challenges, are raising expenses. Base pay rates and material costs have both gone up. Hence, associated commercial property insurance costs have also increased.

In response, some real estate companies have turned to automating certain capacities such as leasing, tenant management, and rent collection. Such commercial real estate services are becoming an increasingly popular option.

Property Replacement Costs

Property replacement costs are another reason for insurance rates rising in CRE.

Insurance policies need to bear in mind the rise in labor and construction costs. To address this, insurance companies may need to adjust coverage to make sure that the policy reflects the current property replacement value. Replacements for large-scale property losses have become particularly expensive due to inflation.

Indeed, the producer price of construction equipment and machinery rose by more than 8.8% in 2023, compared to 2022. For context, it was 1.7% in 2020. The costs of structural steel and lumber have also jumped greatly.

Climate scientists anticipate that the increasing frequency and severity of natural disasters and extreme weather events will exacerbate replacement costs in the near future.

Supply Chain Disruptions

According to the ACG report, 82% of firms said that their projects were delayed due to supply chain issues.

Since the Covid-19 pandemic, a myriad of supply chain challenges have occurred. Initially, most of them stemmed from a slowdown in production, increased demand for certain materials and goods, and lower availability.

However, even though operations have since resumed and production levels have increased, the demand for some materials still outweighs inventory.

Disruptions have been further exacerbated by rising energy and fuel costs, geopolitical conflicts, congestion at ports, climate-related disasters, and labor shortages.

Lastly, the risk landscape has been affected by the current unpredictability of supply chain networks. Insurers require predictable and stable supply chains to accurately assess and price risks. Disruptions cause uncertainties that complicate the underwriting process.

Hence, to manage the uncertainties, insurers increase costs, which are then passed on to commercial real estate owners in the form of higher premiums.

Conclusion

As the factors influencing rising insurance costs in CRE continue to evolve, commercial property owners and insurers must learn to navigate an increasingly challenging landscape.

The way industry leaders choose to do this could be vital to establishing a strong foundation of operations in the long term. The benefits gained from digital transformation and streamlined operations can be worth it.

Silverskills provides vital back-end services for commercial real estate companies. We optimize your processes while allowing you to focus on core activities that help you stay ahead of the competition. Contact us now to get started.