After stagnating for much of 2020 and 2021 due to the COVID-19 pandemic, the commercial real estate market has rebounded, including a year-over-year quarterly increase of 7% in the second quarter of 2021.1
Inflation, supply chain and new risk runover have all caused property values to rise, along with the cost of construction. While rising real estate prices may be good for some, it can also leave real estate owners and operators underinsured.
No matter if it’s a single commercial property or a large real estate portfolio, the rise in prices means owners and operators need to reevaluate their coverage to ensure their coverage is adequate.
The unintended effects of inflation
When extending existing insurance from 18 to 24 months due to a construction delay, for example, the insurance coverage starts from the original construction start date. This increases risk, as there’s a structure on what was once a plot of land: Insurance needs to cover more than construction delays but the building itself.
As real estate prices climb along with construction costs, here’s four things to consider when reevaluating existing property coverage:
1. Co-insurance agreements: Co-insurance clauses in property policies state that the insurance company agrees to replace damaged buildings, but if the real estate owner doesn’t insure their properties to the full amount, it makes the building owner a “co-insurer,” making the owner liable for as much as 20% of the costs. This occurs when the loan did not account for delays or for inflation.
It’s important to sidestep the effects of co-insurance clauses, as inflation has increased replacement costs. While insurance contracts may have provisions for the increased cost of construction, it often covers only an additional $25,000, which may not be enough to cover the additional costs of rebuilding. Having a higher estimate (and granted, a higher premium) at the outset of construction will help shield against co-insurance issues.
2. Blanket limits: Blanket limits cover numerous properties in a single portfolio. Blanket limits let real estate owners cover a single claim in any location. Insuring at a value that’s higher than the largest property in a portfolio will cover the additional costs of replacement should a catastrophe or fire strike. Blanket limits cost more up front but provides a cushion for the long term.
