To say that 2023 has been difficult for real estate investors would be an understatement. Rising interest rates, vacant commercial real estate and a general slowdown in rent increases have combined to put a huge kink in most real estate investors’ profit chains. And a new threat is on the horizon that could shrink investor returns even further: Insurance rates are going up in some of real estate’s most critical markets.
First, there is Florida, where major insurers recently presented a request to the Florida Office of Insurance Regulation (OIR) to raise premiums astronomically. The proposed rate increases, which could see commercial insurance premiums in Florida jump by 60% and up to 103% for condominiums, come on the heels of insurers paying out billions in claims because of multiple hurricanes that have hit the Sunshine State in the last few years and caused billions of dollars in damage.
The insurance business is complicated, and many carriers depend on “reinsurance,” a specific type of insurance carriers buy to insulate themselves from an avalanche of claims after disasters strike. Florida’s largest carriers of home and commercial lines have seen reinsurance premiums skyrocket by 50% to 80% in some cases. With these types of increases, the insurers have no choice but to pass the costs on to consumers.
The expected premium increases come at about the worst possible time for Florida homeowners and real estate investors. Throughout the pandemic, Florida was one of the most vibrant real estate markets in the nation. It drew millions of new residents from major cities like New York who were looking for affordable real estate and warm weather. This led to a boom in construction and real estate values, which is normally good news for investors.
But there is such a thing as being a victim of your own success, and the proposed insurance rate increases are a textbook example. As property values rose, homeowners and investors could enjoy the increased profits, but the more valuable an asset becomes, the more expensive it is to insure.
What This Means For Investors
Rising premiums are a major inconvenience for homeowners, but they can choose to be uninsured if they own the property free and clear. That is not the case for commercial property owners and condo developers, both of whom have assets that are heavily represented in many real estate investment trusts (REITs) and property portfolios.
Most of those assets are financed, which means they must carry insurance as a condition of the mortgage so the bank isn’t left holding the bag if there is a disaster. At a time when many of these assets are coming up for refinancing that will likely be at higher interest rates than the developers anticipated, the cost of insuring the properties may rise another 60%.
Some of that cost can be passed on to residents and tenants in the form of rent increases. But the reality is most REIT assets are purchased with the intention of raising investor profits through increased rent. If a portion of those rent increases is allocated to cover increased insurance costs, investors will feel the pinch.
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Florida Is Not The Only State Dealing With Insurance Problems
Florida isn’t the only state wrestling with natural disaster-related insurance issues. California, another state where many REIT assets are located because of strong property values, is experiencing an insurance crisis of its own. State Farm Insurance Co., one of the nation’s largest insurers, recently announced it would no longer write policies on commercial and residential properties in California.
State Farm specifically cited the high cost of paying claims to policy holders affected by the wildfires that have ravaged California for the past several years. The move is significant for several reasons. First, one of the most well-heeled legacy insurance companies in America has decided it can no longer raise premiums quickly enough to make insuring real estate in California profitable for its shareholders.
Second, the loss of such a large insurance provider will lead to less competition among the insurance carriers who continue to operate in California. That translates into higher premiums for policy holders. The commercial sector will feel the pain from these premium increases in California for the same reasons as commercial investors in Florida — they have no choice but to carry insurance on any asset they finance.
This means portfolios and REITs that are heavily invested in California have another external factor putting pressure on their earnings. That’s in addition to competition from other commercial assets in the same class and higher interest rates on financing.
What Can Investors Do?
It’s true that California and Florida real estate is highly sought after and has a long history of being profitable for investors. It’s also true that investing in top-of-the-market properties in premium locations like California and Florida is expensive and getting more expensive every day. But the country is much larger than just California and Florida.
Profitable real estate offerings exist in real estate markets across the country, many of which may have some more investor-friendly buy-ins and expense profiles. Investors can find these kinds of opportunities on real estate crowdfunding and investing platforms, and they are worth looking into. In the meantime, investors considering assets in Florida and California should be extremely discerning and conduct thorough due diligence on both the finance and the insurance costs.
Looking for a way to boost returns? Benzinga’s Real Estate Offering Screener has the latest private market investments with offerings available for both accredited and non-accredited investors.
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