A common practice when underwriting multifamily apartment deals is to assume a stabilized insurance expense equal to the T-12 insurance operating expense. In other words, the assumption is that the insurance premium paid by the current owner will remain the same after acquisition.
This practice was indeed correct for the past five to ten years. However, according to commercial insurance expert Bryan Shimeall, who was interviewed on the Best Real Estate Investing Ever podcast, this is no longer a safe assumption.
Due in part to the onset of coronavirus, as well as to the increase in the number of people entering the commercial real estate investment realm, insurance rates are rising fast.
Towards the end of 2019, the insurance market transitioned from a soft market to a hard market.
In a soft market, insurers are competing for apartment investors, resulting in more competitive rates. Therefore, when underwriting deals, apartment operators were assuming the T-12 insurance rate would remain the same after acquisition, or even potentially decrease.
However, in a hard market, the opposite is true and apartment investors are competing for insurers. As a result, insurance rates are rising.
The magnitude of the increase is geographically driven. According to Bryan, an apartment investor should expect between a mid-single-digit and up to a 20% increase in the insurance rate when underwriting deals.
He also said that insurance companies are pickier about the types of apartments they will insure, as well as offering non-renewing insurance policies. If an apartment qualifies for insurance, there is no guarantee that it will continue to receive the same rate, the same coverage, or any coverage at all once the initial contract has expired.
Now that you know about these recent changes to insurance rates, what changes should you make when underwriting apartment deals?
The most important thing you need to do is have a conversation with your real estate insurer. If you do not have one, you need to find an insurance company or broker that specializes in real estate.
Ask the insurer about the insurance rate increases in the market you invest in.
Another important factor besides geography that is driving the rate increases are the history of losses. Bryan says it is more important than ever to provide your insurer with the history of losses as soon as possible.
Once you know you are serious about a deal, email the listing broker (if on-market) or the owner (if off-market) and request a copy of the history of losses for the apartment.
Your insurer will need accurate and complete information about the history of losses at the property to provide an accurate insurance quote. Without the history of losses, the insure will generate a quote based on a clean history.
If your insurer obtains the history of losses report that isn’t clean, the insurance rate will be higher. Depending on the type of losses, the insurer may decide to not provide insurance at all.
The worst-case scenario is your insurer receives the history of losses and won’t provide insurance on the apartment after you’ve invested tens of thousands of dollars into due diligence. Another bad scenario is the new insurance quote is significantly higher than your original projections and you need to back out of the deal or renegotiate a new purchase price.
Therefore, to avoid canceling contracts and wasting thousands of dollars, do not assume an insurance rate that is the same as the current insurance rate. Instead, have a conversation with your insurer prior to submitting a contract to understand the projected rate increase in the market. Then, obtain a history of losses as soon as possible so that your insurer can provide you with the most accurate quote before you have progressed further into the due diligence period.Follow Me: