Insurance Costs and Your Proforma

In my former life in private equity and real estate, underwriting assets was a key component of my day. Insurance is a fickle mistress and the ebbs and flows of insurance premiums can have a fundamental impact on the performance of your assets as well as the types of debt products that may be available to you when acquiring a new deal or going through refinancing.

What you don’t know can hurt you. Overpricing or underpricing an asset during acquisition are both horrible situations to be in when going hard on a deal. This presumption of accuracy can be dangerous when you are evaluating a big-ticket line item like insurance.

Understanding commercial real estate insurance costs

It’s important that, as an owner, you make sure you understand the historical costs of insurance, who your seller is, why the premium is priced the way it is, and who your lender is. These factors are all incredibly important to understand your insurance expense assumptions.

Getting an indication is key to understanding how much you will pay for your premium. It’s easy to take a look at the trailing 12 and assume that you will get the same or a better rate than the previous owner or even if they will give your asset a blanket price per door or price per sqft.

This is why it’s important you understand the previous loan type against the loan you plan to get. For example, a multifamily Freddie Mac or Fannie Mae loan often requires special coverage that you may or may not see with other lenders. These include special types of flood coverage or terrorism insurance which will often drive up your rate.

Insurance considerations

Things to consider (topics we will discuss in this series in the coming weeks):

1. Do you need special coverages or is your asset in a risk zone or has the risk changed since the last pricing of the premium?
2. What do your loan covenants require of you for insurance limits?
3. Is your lender requiring you to obtain insurance based on the purchase price or replacement costs?
4. What is the current state of the market and how much should you expect your premium to rise annually?

Are your proforma year over year growth rates in line with the true historical growth rates of the insurance industry and will that affect your DSCR, Cash on Cash, and IRR?

1. How much will your premium rise with a claim and did the previous owner have a claim? 
2. Do you have loss runs and why are they important?
3. How often do claims events occur?

Risk tolerance and insurance pricing

Carrier risk tolerance changes over time and markets harden and soften with the change in risk. Insurance pricing adjusts accordingly.

Remember: not all policies are created equal. We will cover how to mitigate risks in underwriting insurance costs in your proforma and help to provide some context on pricing.

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