Key Points:

• Commercial property insurance premiums have significantly increased over the past five years, driven by factors such as increased weather-related damages, rising replacement costs, and reinsurance availability.
  
  
• The increase in insurance premiums varies by location, with properties in disaster-prone areas experiencing the highest increases.
  
  
• Large institutional operators can negotiate better insurance rates, while smaller operators, especially in high-risk areas, face greater financial strain due to rising premiums.

Though property insurance is a familiar expense for commercial real estate (CRE) operators, it historically hasn’t been one that keeps people up at night. That may well be changing. Over the last five years, commercial property insurance premiums have increased markedly, in some extreme cases doubling in the course of a year. According to research from the Minneapolis Federal Reserve, multifamily insurance premiums increased at an average annual rate of 45 percent in 2024 alone. 

While rental income has also grown substantially in the last five years, insurance premiums have grown more rapidly. As growth in insurance premiums outpaces growth in rental income, a growing share of that rental income must be allocated towards insurance expense, which makes buildings less profitable. All else equal, declining net operating income, or the income available to owners after accounting for all expenses except debt service costs, also results in falling property valuations – a double whammy for property owners and operators.

“Smaller operators in disaster-prone areas will bear the greatest brunt from rising insurance premiums, which suggests that, over time, there may be some consolidation in disaster-prone areas as larger operators acquire properties from smaller ones.”

Insurance Costs Increase Everywhere, But Much More in Certain Locations

When comparing costs over several years, it’s useful to benchmark them relative to gross rental income, which is the income generated by a property before accounting for any expenses. Both rents and expenses change over time, so comparing expenses relative to gross income makes the across-time-period comparison more “apples-to-apples.” 

Before the pandemic, insurance premiums typically hovered in the range of 1-to-2 percent of gross rental income. The top part of the following chart shows property insurance premiums as a percent of gross rental income for buildings with median property insurance expense. For these median properties, property insurance premiums accounted for approximately 2 percent of gross rental income for multifamily buildings and between 1 to 2 percent for all other asset classes. This has typically been what owners and operators expect to pay in insurance expense on an annual basis. By 2023, though, property insurance expenses for median buildings had increased to between 1.6 percent and 3.3 percent of gross rental income. In the case of multifamily properties, the way to interpret this is: rental incomes would need to increase by an additional 1.3 percent (3.3 percent minus 2 percent) to offset the increase in insurance premiums.

However, there is great variability in insurance expense burden depending on a property’s location. The bottom portion of the chart shows the change in insurance premiums for buildings within the top 5 percent of insurance expense burden. Here, the increases from 2018 to 2023 are far more substantial. In 2018, insurance expenses as a percent of gross rental income ranged from 2.9 to 6.3 percent, but by 2023 that had increased to between 5.3 and 10.8 percent. In the case of multifamily properties, this would suggest that rents would need to increase by 4.5 percent beyond what they already have in the last five years to make up for the lost income due to higher insurance premiums.

What’s Driving the Increase in Insurance Premiums? 

Several common threads are driving these increases. The first is the increasing frequency of weather-related property damage, resulting in higher losses. This is largely uncontrollable at an individual level – as long as the frequency of weather-related damage continues to increase, we should expect insurers to increase premiums to offset growing losses. 

The second is the recent surge in replacement costs. Compared to pre-pandemic levels, material costs have risen by approximately 35 percent for all types of commercial properties, outpacing the cumulative 23 percent inflation experienced by consumers. Higher replacement costs translate to higher premiums since repairing or rebuilding a damaged property costs more. 

The third is reinsurance. Reinsurance is coverage that insurance companies take out to insure their own exposure. For example, imagine a regional insurance provider has issued coverage for $20 million of damages, but only wants to be exposed to $10 million in losses. They can go to a reinsurance company to reduce their exposure from $20 million to $10 million. Unlike the frequency and severity of weather-related damages, reinsurance availability ebbs and flows depending on the supply of reinsurance capital and how risk-tolerant that capital is at any given time. When reinsurance availability, or “capacity,” decreases, regional insurers are on the hook for more damages and raise premiums to offset that risk. As reinsurance availability increases, it acts as a pressure release valve, limiting upward pressure on insurance premiums. Reinsurance capacity was limited in 2022 and 2023, but more recently has been increasing, a cautiously optimistic development in the property insurance world. 

What’s a Property Owner to do?

There are only so many ways to manage insurance expenses. Unlike some residential markets, where people without mortgages can choose to “go bare” and live in a home without any insurance, CRE investments usually involve too much money to take that sort of downside risk. Indeed, operating without any property insurance would likely be viewed by investors as negligence if something were to happen to the property. Commercial properties are also infrequently purchased without a mortgage, and CRE lenders almost always require borrowers to carry property insurance.

So, what can CRE operators do to manage rising insurance premiums? They could opt for higher deductibles to lower premiums, but that only increases profitability today in exchange for an increased risk of loss after a weather event later. There are also more complex solutions, such as layering different types of coverage, or parametric coverage, which pays out based on the occurrence of a type of weather event rather than damage actually incurred by a building. Of course, property owners can also use less debt, offsetting their higher insurance premiums with lower interest expense. This benefits cash flow from operations, but does not alleviate the valuation compression caused by higher operating expenses.

Large, institutional operators have the option to negotiate directly with insurance companies for better per-building premium rates. However, this is rarely an option for mom-and-pop operators who may own only one or two rental properties. Consequently, smaller operators in disaster-prone areas will bear the greatest brunt from rising insurance premiums, which suggests that, over time, there may be some consolidation in disaster-prone areas as larger operators acquire properties from smaller ones.