Commercial Real Estate Insurance Woes

Commercial property and multifamily unit owners overlooking either the Atlantic Ocean or the Gulf of Mexico can easily brag about having a million-dollar view. And in some areas, they can also brag about having a trillion-dollar insurance bill.
   In the face of the damage brought by Hurricanes Katrina and Rita in 2005, property insurance rates in hurricane-prone areas have jumped dramatically. Lenders and servicers in these areas have scrambled to face a new and extremely expensive environment, where old rules regarding property insurance have been hastily rewritten in order to maintain business operations.
   The subject of covering insurance gaps in high-risk areas was addressed during the Mortgage Bankers Association's recent Commercial Real Estate Finance/Multifamily Housing Convention & Expo during a session titled "Gone with the Wind: Challenges of Lending and Insuring Properties."
   Danny Seagraves, niche principal with Gallagher Real Estate Services, represented the insurance industry during the panel discussion, and he pointed out that seven of the 10 most expensive hurricanes in American history occurred in the period between August 2004 and October 2005. The $40.6 billion in damages from Hurricane Katrina, he noted, was nearly double the intensity of the second-most costly hurricane, 1992's Hurricane Andrew.
   Despite the damage created by the hurricanes, Seagraves pointed out that the insurance industry hardly suffered. "Since 1991, the primary markets have made money," he said. "They've made a lot of money. And 2005 was their most profitable year."
   In fact, the only time in the past 16 years when the insurance industry suffered a loss was in 2001, and that was due solely to the 9/11 attacks rather than a natural disaster. The problem with property insurance in wind-prone areas, Seagraves observed, is not attributable to insurers, but to reinsurers, who opted out of regions with histories of high damage.
   "The reinsurers went somewhere else," he said. "They could not make it in those wind-prone areas. They went to places like Iowa, where they don't have hurricanes. And the reinsurers are not coming back."
   So where does that leave lenders and servicers? According to Damian A. Wach, director of real estate investment banking for Eurohypo AG, the depth and scope of coverage parameters for these areas are now fairly flexible.
   "Even if 100 percent coverage is achieved at loan closing, some lenders are allowing "commercially' available language in the loan documents in anticipation of potential future coverage shortfalls," said Wach.
   To make up for the absence of reinsurance, Wach noted that lenders are taking new strategies that include:

   *   requiring windstorm insurance limits to the lesser of 100% of the replacement value or loan value;

   *   softening insurance rating requirements and allowing self-insurance or captive carriers such as Citizens Property Insurance Corp., created by the Florida state government for those who cannot find or obtain private insurance coverage;

   *   structuring insurance with higher deductibles; and

   *   in some cases, accepting less than the 100% windstorm insurance if the gap in coverage is filled by either a letter of credit, additional borrower covenants or guarantees, special reserves or loan holdbacks, reduced loan proceeds or windstorm probable maximum losses (PML).

   "The lenders are still struggling with the 100 percent replacement value coverage," bemoaned Wach, who added that some possible solutions being considered today include the development of an accurate and reliable windstorm PML (not unlike the PMLs in place for earthquake-prone regions), an exploration of different solutions tailored to lenders' needs, and a new effort to educate lenders about the risks of alternative windstorm insurance.
   Yet it is not only lenders who are facing wind-blown challenges. The government-sponsored enterprises and the Department of Housing & Urban Development (HUD) have also been flummoxed by the situation, according to Wendy Melton, vice president for DB Berkshire Mortgage.
   "At Fannie Mae, waivers are allowed for coverage in an amount of less than 100 percent of replacement cost to cash value," she said. "However, that's not less than the mortgage balance. Deductibles have been increasing from five percent to 10 percent, and in rare cases, premium financing is allowed when there is no other way. Fannie will consider captives or state windstorm pools on a case-by-case basis."
   Melton noted that Freddie Mac issues far fewer waivers than Fannie Mae, always on a case-by-case basis. Among its waivers are personal guarantees for the difference in required insurance and obtainable insurance, as well as lines of credit or cash escrows to make up the difference.
   "But there's not much flexibility with the HUD requirements," she noted. "They've had no insurance requirement updates for some time."
   Melton suggested that legislative reforms might calm this issue, with possible solutions including stronger building codes, tax breaks for insurance companies writing policies in wind-prone areas, new limits on premium increases, and relaxing state laws requiring state-run property insurance companies to charge 10% higher rates than private insurers.
   "Joint efforts between the insurance industry, lenders, consumers and public policy makers are needed to address this situation fairly and realistically," she remarked.
   Seagraves added that his colleagues in the insurance industry would gladly join this crusade, albeit with one caveat. "We'd be happy if we could make money," he said.


CapitalSource Inks
Seniors Housing Deal

CapitalSource Inc., a Chevy Chase, Md.-headquartered real estate investment trust, has completed the purchase of 77 long-term care facilities for approximately $462 million.
   The facilities are subject to long-term leases with a weighted average term of 9.4 years, the company says. The properties are managed by 29 operators and are located in 22 states.
   "These transactions validate the significant growth opportunities we anticipated in the sale-leaseback market and are a good example of our expanded ability to serve new and existing customers," says John Delaney, CapitalSource's chairman and CEO.

CORE Acquires
2,399-Unit Portfolio

CORE Realty Holdings LLC, Newport Beach, Calif., has acquired a 2,399-unit multifamily portfolio on behalf of investors for an offering price of $188 million.
   The acquisition was a principal-to-principal transaction with no broker representation. In addition, a member of the selling group will retain day-to-day property management and capital improvement supervision after closing. The project was offered to a total of 208 investors in eight separate offerings, which are now fully subscribed and closed, the company says.
   "In the aggregate, this is the largest tenant-in-common value-added multifamily acquisition in the country to date, making this acquisition a milestone in our industry in terms of its size," says Sterling McGregor, CORE's chief investment officer.
   Three of the communities are located in Richmond, Va., with the remaining five communities located in Greensboro, N.C., the company adds.



WHAT: The property is a two-building, 143,450 square-foot medical office campus. It comprises 15111 Whittier Blvd., a 58,527 square-foot, four-story office building, and 15141 Whittier Blvd., an 84,879 square-foot, five-story office building.
   WHO: Scott Bottles, Steve Orchard and Sean Lurry, all with Los Angeles-based George Smith Partners, arranged the financing on behalf of Jamison Services. Marc Renard, Manfred Schaub and Alison Berglas of Cushman & Wakefield represented Broadreach Capital Partners in the sale.
   $$$: $26.1 million.
   TERMS: A 10-year, interest-only loan was leveraged at 90% LTV.
   George Smith Partners: (310) 557-8336.


WHAT: This 100,361 square-foot Class A office property is home to major tenants such as Info Highway Communication Corp. and the U.S. Government General Services Administration.
   WHO: Ernest DesRochers, senior vice president and managing director of NorthMarq Capital Inc.'s greater Westchester NY/CT regional office, and Charles Cotsalas, vice president in NorthMarq's Long Island regional office, arranged financing on behalf of InLaw Realty Associates through Goldman Sachs Mortgage Capital.
   $$$: $13.2 million.
   TERMS: Financing was based on a 10-year term with a three-year interest-only period, followed by a 30-year amortization schedule.
   NorthMarq: (516) 822-2700.


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