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From atmospheric rivers to severe heatwaves to rampant wildfires, the repercussions of climate change continue to have a resounding impact on the U.S. commercial real estate sector – which as a result has been especially hard hit by rising insurance premiums.

From 1980 to August of this year there have been 395 confirmed weather/climate disaster events in the United States with losses exceeding $1 billion each, according to the National Centers for Environmental Information.  

Specific examples include

• Hurricane Beryl which pummeled Texas in July of this year, causing widespread wind damage with estimated costs ranging from $2 billion to over $6 billion;
• Hurricane Ian in 2022, causing over $50 billion in property damage to Florida; and
• The 2018 Camp and Woosley fires in California, triggered by extreme heat and drought – causing over $14 billion in property damage.

Insured losses almost quadrupled from $25 billion in 2019 to $99 billion in 2022.  The repercussions of more recent events such as Hurricanes Helene and Milton still remain to be seen.

The increased frequency of these events, exacerbated by increasing construction costs and population growth in high-risk areas, are causing insurance premiums to rise.

Nonclimate Factors Further Inflate Insurance Premiums

Climate change and the resulting extremes aren’t the only drivers of escalating insurance costs. Soaring premiums stem from various other factors, among them inflation, population growth, crime and regulatory challenges.

Inflationary pressures on labor and materials, property value increases in high-risk area and the limitations imposed by state regulations on premium adjustments all contribute to the upward trajectory of insurance rates.

These increasing costs are placing considerable strain on property owners, investors and developers — leading to difficult decisions regarding operating budgets, financing and investment strategies.

Inflationary effects on labor and material costs are expected to continue rising through 2025 — particularly as development activity picks up following the anticipated U.S. Federal Reserve interest rate cut. Americans who migrate to high-risk areas are also building higher-value homes, which have high replacement values.

This has a significant impact on insurance premiums and — when coupled with increased demand — carriers are either going insolvent, halting the writing of new policies or leaving the state altogether, and insurance premiums are bound to rise significantly.

Crime, including retail theft and other property crimes, is also a significant contributor to increasing insurance premiums. As more people move to states like California, Florida or Texas — areas prone to extreme natural events — the overall risk landscape changes,
including the potential for crime.

The combination of increased population density and evolving crime dynamics has led insurers to reassess the risks associated with certain states. This is particularly evident in the shifting methodologies insurers use to rate crime risks, which have affected affordable
housing projects, including those with subsidized units, affecting liability policies and deductibles.

Additionally, models used by insurers to calculate premiums have been influenced by factors like eviction moratoriums, which have altered the calculus of risk for insurers. Property value increases in high-risk areas have further contributed to rising insurance premiums. As demand for housing continues to grow in these states, the corresponding increase in property values also raises the costs insurers must cover, thus edging premiums ever higher.

For example, most of the development booms in Florida — i.e. Miami and Palm Beach — are in areas vulnerable to hurricanes and flooding where insurance premiums are 50% higher than inland areas.

Insurers cannot raise premiums at the same rate as the rising costs of the assets they insure. Insurance carriers are often restricted in their ability to independently adjust prices, as any increase must be approved by the state’s insurance department.

As a result, insurers’ premiums often lag behind the escalating costs of coverage, leading to
potential losses when operating in these high-risk areas.

The Role of Insurance in Real Property Investments

The insurance market for real property varies greatly by state and specific geographic areas within each state.

Insurance is a critical component of risk management within the commercial real estate industry.

Property insurance, among numerous other types of insurance coverage, protects against potential losses from property damage due to events such as fire, theft, vandalism and natural disasters and is essential for safeguarding the significant financial investments made by commercial real estate stakeholders.

In addition, insurance plays a key role in maintaining cash flow stability for property owners and investors. When a property is damaged, insurance can offset the costs of repairs or reconstruction, allowing businesses to minimize disruption to their operations.

Furthermore, commercial and residential lenders typically require comprehensive insurance coverage as a condition for financing, ensuring their investments are protected.

Reconciling Rate Increases With Regulatory Constraints

There is a complex interplay between risk assessments, regulatory environments and market dynamics that results in varying outcomes geographically.
In some states, insurance rates have risen significantly, while in others, insurers are unable to keep pace with ever increasing costs.

In certain high-risk areas like California, Florida or Texas, state insurance departments may approve significant rate hikes in response to the increased frequency and severity of natural disasters — necessary for insurers to manage heightened risks and avoid insolvency.

Insurers might face premium caps, even as the costs of construction, labor and materials continue to rise. This regulatory limitation results in premiums that do not fully cover the rising risks, leading to potential losses for insurers.

When insurers cannot adjust their rates adequately, they may opt to withdraw from the market, leaving property owners with limited options and higher costs.

Impacts of Rising Insurance Costs

Due to rising insurance costs, deal flow has been in decline since 2021. If a deal for a multifamily building has not fallen apart, at a minimum there will be significant divergence in the underwriting of insurance costs per unit in such a property.

Insurance costs may vary from carrier to carrier, some offering $1,500 per unit while others offer $800 per unit, such a variance has a significant impact on net operating income, which plays a role in negotiating the purchase price.

Amid a slowdown in deals and increased risk in certain regions, successfully closing a transaction requires buyers to increase the weight of higher cost of insurance in the negotiation of the purchase price.

In other words, as insurance costs increase, the underwritten decreases in net operating income — which means the purchase price would be lower to achieve target returns.

Property owners may attempt to cover higher insurance costs through increased rents, at the risk of causing higher vacancy rates. Tenants facing increased costs may choose to terminate leases and relocate to more affordable properties, either within the same market or in different regions.

This potential loss of tenants can lead to longer vacancy periods, reducing the overall profitability of the property and further straining the financial position of property owners. In extreme cases, properties with persistently high vacancy rates may become financially untenable, leading owners to consider repurposing or even selling the assets at a loss.

Many landlords are facing increased pressure on their operating budgets due to rising insurance rates. These higher costs can strain the financial resources available for property maintenance, capital improvements and other necessary expenditures.

Owners may be forced to make difficult decisions about where to allocate funds, potentially deferring maintenance or delaying upgrades. In some instances, insurers are requiring owners to replace roofing, plumbing and other property infrastructure to qualify for coverage.

Over time, this can lead to a decline in the overall quality and competitiveness of the property, further exacerbating financial pressures.

The rising cost of insurance can also have a significant impact on property owners’ ability to secure financing or refinancing. Lenders typically assess loan-to-value ratios when evaluating financing applications, and higher insurance costs can reduce the value of the property, thereby affecting the property’s LTV.

In high-risk areas, lenders may view properties as less attractive collateral, making it more difficult to obtain favorable financing terms. This can limit the property owners’ ability to invest in new properties, refinance existing debt or access capital for property improvements.

For property owners looking to sell their assets, exorbitant insurance costs can complicate exit strategies. Potential buyers may be deterred by the high cost of insurance, particularly in regions prone to natural disasters.

Forward-thinking investors are taking a cautionary approach — evaluating each transaction to determine whether despite the high risks of real estate in certain regions, capital would still be attracted to that same region in the future.

This can result in a smaller pool of interested buyers and lower value offers. In some cases, owners may be forced to sell at a discount or hold onto the property longer than intended, which can disrupt financial planning and affect their overall return on investment.

Conclusion

A confluence of factors is fueling rising insurance premiums for commercial property owners. Insurers are caught in a complex web of rising costs, regulatory constraints and evolving risk assessments, leading to varying impacts across different regions and asset types.

High-risk states have attempted to balance substantial premium rate hikes in response to heightened risks, with regulatory controls; however, as evidenced by California and Florida, premiums still lag behind actual costs of coverage leading to some insurers leaving and others halting issuance of new policies.

As the industry adapts to these challenges, a proactive approach to risk management, including innovation in building practices and strategic investment decisions, will be crucial for maintaining long-term viability.

The future of the real estate sector will depend on its ability to balance various factors while continuing to provide value and stability in an increasingly uncertain environment.

Ulrick Matsunaga is an associate at Crosbie Gliner Schiffman Southard & Swanson LLP. The article was published in Law360 (subscription only).