With the large number of catastrophic loss events in recent years we have seen insurance companies leaving markets like Florida, and California, and the resulting higher cost of property insurance has become a big drain on NOI and property values for commercial real estate.
Given that property insurance premiums are increasing by as much as 300% in some markets, investors are struggling to determine whether the high cost of insurance is temporarily (and therefore creates a buying opportunity), or whether this is a systemic repricing of risk which will reset property values going forward.
To better understand the dramatic increase in insurance costs we need to dive into the factors that have driven the massive insurance losses of the last few years. Certainly, climate change plays a role in the increased frequency and severity of storms, wildfires, and other weather-related losses. Higher global temperatures are fueling stronger and more frequent storm systems.
Additionally, post pandemic inflation and a sluggish supply chain drove up replacement and repair costs faster than insurance companies could catch up. This is compounded by a systemic shortage of trades labor in the US, which continues to drive up the cost of skilled labor and increases the cost of repairs after a loss event.
These factors have compounded, resulting in insurance companies underpricing the risk of loss events. This was further complicated by an overly competitive reinsurance market, as a result of the trillions of dollars governments around the world dumped into the economy, flowing through to the investment markets. Today capital in the reinsurance market has all but dried up, as the outflows of capital reimbursing losses has exposed the insurance market to the fact that they had severely underpriced the risk.
Normally the fact that real estate investments are backed by tangible assets is an advantage that protects investors from the volatility seen in intangible assets. However, the risk with tangible assets is that they can be physically damaged or destroyed, and insurance hedges against this risk.
Since insurance hedges the risk of damage or loss for everything – from properties, vehicles, businesses, health care, and almost anything else you can think of – it is insurance that underpins the value of assets, and of the economy as a whole. Material repricing of this risk is a repricing of the entire real economy.
So, where does this leave us? It is tough to say with certainty. Insurance markets have historically been cyclical. Capital tends to flow out when large losses are made, and capital tends to flow back in when large profits are made. And given the increasing premiums that insurance companies are now charging, we would expect their profits to be significant in 2023 (absent any major new catastrophes).
But maybe things are different this time. Climate change appears to be having a profound impact on the level of risk and inflation may be here to stay for a few years yet. There is a good chance that higher insurance costs are here to stay, and that real estate located in coastal markets, or markets with higher catastrophic risk, will see material devaluation due to increased insurance costs.
That being said, demand for housing in coastal markets remains strong as these are still very popular markets and are still experiencing positive net migration.
A dynamic market creates opportunities for the astute buyer. It will be interesting to see how these factors play out over the next few years.
To learn more about how we can help you to generate superior investment results through professionally managed Real Estate investments, click here to register for our investor club.
Insurance makes the (multifamily) world go round
With the large number of catastrophic loss events in recent years we have seen insurance companies leaving markets like Florida, and California, and the resulting higher cost of property insurance has become a big drain on NOI and property values for commercial real estate.
Given that property insurance premiums are increasing by as much as 300% in some markets, investors are struggling to determine whether the high cost of insurance is temporarily (and therefore creates a buying opportunity), or whether this is a systemic repricing of risk which will reset property values going forward.
To better understand the dramatic increase in insurance costs we need to dive into the factors that have driven the massive insurance losses of the last few years. Certainly, climate change plays a role in the increased frequency and severity of storms, wildfires, and other weather-related losses. Higher global temperatures are fueling stronger and more frequent storm systems.
Additionally, post pandemic inflation and a sluggish supply chain drove up replacement and repair costs faster than insurance companies could catch up. This is compounded by a systemic shortage of trades labor in the US, which continues to drive up the cost of skilled labor and increases the cost of repairs after a loss event.
These factors have compounded, resulting in insurance companies underpricing the risk of loss events. This was further complicated by an overly competitive reinsurance market, as a result of the trillions of dollars governments around the world dumped into the economy, flowing through to the investment markets. Today capital in the reinsurance market has all but dried up, as the outflows of capital reimbursing losses has exposed the insurance market to the fact that they had severely underpriced the risk.
Normally the fact that real estate investments are backed by tangible assets is an advantage that protects investors from the volatility seen in intangible assets. However, the risk with tangible assets is that they can be physically damaged or destroyed, and insurance hedges against this risk.
Since insurance hedges the risk of damage or loss for everything – from properties, vehicles, businesses, health care, and almost anything else you can think of – it is insurance that underpins the value of assets, and of the economy as a whole. Material repricing of this risk is a repricing of the entire real economy.
So, where does this leave us? It is tough to say with certainty. Insurance markets have historically been cyclical. Capital tends to flow out when large losses are made, and capital tends to flow back in when large profits are made. And given the increasing premiums that insurance companies are now charging, we would expect their profits to be significant in 2023 (absent any major new catastrophes).
But maybe things are different this time. Climate change appears to be having a profound impact on the level of risk and inflation may be here to stay for a few years yet. There is a good chance that higher insurance costs are here to stay, and that real estate located in coastal markets, or markets with higher catastrophic risk, will see material devaluation due to increased insurance costs.
That being said, demand for housing in coastal markets remains strong as these are still very popular markets and are still experiencing positive net migration.
A dynamic market creates opportunities for the astute buyer. It will be interesting to see how these factors play out over the next few years.
To learn more about how we can help you to generate superior investment results through professionally managed Real Estate investments, click here to register for our investor club.