A Q&A with Thomas Price
Deciphering the Complexities of Insurance for Investors, Lenders and Agents When real estate investors secure mortgages for a portfolio of properties, the complexity of their insurance needs may be more than they bargained for. In a changing real estate environment, it has become more challenging to anticipate and cover common risks. Their mortgage lenders, too, often need help untangling the nuances. What should both parties know? REI INK asked Thomas Price, President, Incenter Insurance Solutions, for his insights. Why has insurance coverage become such a complicated issue for real estate investors and lenders? When investors have a portfolio of income properties such as single-family and multifamily rentals, then they need commercial property insurance, which is inherently more complex than residential insurance for individual homeowners. This is due to the greater number of properties involved, their varying locations, and differing state and municipal regulations. Moreover, new risks such as floods, intense storms, supply chain interruptions, and a volatile economy can also make a larger impact, proportionately, on these commercial portfolios. It is not just real estate investors who need to navigate this maze. Their mortgage lenders and insurance agents are continually addressing the complexities, too, and every party has a different outlook and priorities. Could you explain this disparity? Real estate investors understand the importance of insurance, but they have operating margins to maintain. They may see insurance as a cost center that reduces their yields and need education on how a changing risk environment should be prompting a more careful look at their policies. Lenders’ focus, on the other hand, is on market value—both from the origination and trading sides. The amount they have available to lend—and the value that they need to protect—will vary with the direction of the real estate market. The ultimate ownership of these loans is another critical consideration for lenders. If they plan to raise cash by selling portfolios to the secondary market, then every property must have appropriate insurance. Otherwise, lenders could be in violation of their investor covenants, and the financial consequences could be devastating. Insurance agents bring a third perspective to the party—focusing on properties’ insured value, which could be affected by depreciation, geographical location, and a host of other variables. All these different worldviews need to be reconciled. How easy is it to do this? It can be very challenging, especially during periods of heightened investor activity. In February 2022, for example, 28% of all single-family home purchases were made by real estate investors. Lenders, wanting to streamline and speed these transactions, are hard pressed to keep up with the “usual” title, appraisal and related details. They are not insurance experts and may miss a nuance that they will have to deal with after the fact—when they are attempting to securitize and trade these assets. Investors and their insurance agents, too, will push ahead in a competitive marketplace with their own objectives front and center. Limited inventory and competition from new market players, such as Millennials who have turned into “laptop landlords” (Wall Street Journal), could propel investors to value speed and agility while skipping over some of the finer coverage details. It is important for all parties to step back and assess the new or heightened risks that could reduce their yields in this evolving world. As you are interviewing me, for example, I am reading about a major flood that we might not have fathomed just a few short years ago. Now everyone must anticipate these increasingly common scenarios. When a lender uncovers a potential insurance gap, and investors and their agents are alerted, getting all parties onto the same page can be painstaking—but it is worth it in the long run. What kinds of coverage should all parties be reviewing? They should be reviewing all property and casualty coverage to ensure that it is sufficiently comprehensive. There are three general categories: » Basic peril, which names exactly what a policy will cover, such as ice, tree damage, and theft. Perils that fall outside of this list will be excluded. » Broad peril, which covers a larger group of risks, such as accidental water damage or frozen pipes that burst. » Special “blanket” form insurance which accounts for an even broader list, but still excludes specific risks—ranging from war and terrorism to floods and named storms. Lenders tend to scrutinize this coverage and may want investors to supplement it with additional policies. What about valuing potential losses? What are the considerations here? This is where discussions can become especially complicated. To begin with, there are several values that may be more or less important to the parties involved, including: » Actual cash value, or what a property is currently worth. » Replacement cost to make a property equivalent to what it was before. » Market value, which is determined by an appraisal professional. » The loan value, or the mortgage that the investor received. » Insured value, or how much insurance the property owner has taken out. For example, some lenders might require that investors’ insurance only cover the value of their original loan. In other cases, they may want these investors to be covered for full replacement costs. These lender requirements can lead to issues that should also be addressed upfront. For instance, consider a lender that values properties for insurance purposes by their replacement costs. An investor borrows $450,000 from that lender for a single-family rental, which burns to the ground before it has been refurbished for tenants. Though they would like a $450,000 check from their insurance company, the actual replacement costs are $300,000, so reimbursement will be limited to that amount. To avoid—or at least anticipate—these situations, all parties should be reviewing the insurance on commercial portfolios every year. In today’s investment market, the benefit of protecting lenders’ and investors’ assets, even when potential risks materialize, is too promising to ignore. Thomas Price is President of Incenter Insurance Solutions. The organization’s Lender Insurance Services include real estate investment portfolio reviews of existing insurance, and
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