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Looking out to 2024, a recent Marcus & Millichap report expects commercial real estate development to slow, based on “elevated” interest rates.

Additionally, construction materials costs remain elevated on a historical basis (up 33.5% above pre-pandemic levels), despite a retreat in shipping costs and the average prices of steel and gasoline in recent quarters. Wage growth was up 5.8 percent in 2022.

Projects that have already broken ground or locked in financing are moving forward, but banks have been executing fewer construction loans relative to previous years. Lenders are tightening their underwriting in response to increased risk exposure. Loans that are secured loans are at rates well-above measures recorded prior to the health crisis.

Industrial sector development is needed, but it slowed in Q4 by 40% compared to the first three quarters and further slowing is likely. Amazon’s decision to halt its ambitious warehouse starts for the next three years is another indication.

The total amount of square footage set to be delivered for both office and retail properties is projected to increase year-over-year in 2023, but new proposals in these sectors are showing signs of deceleration.

“The limited competition from new supply should aid performance metrics at existing retail and office properties,” according to the report.

The apartment sector is an outlier, as it continues to see record inventory growth, according to the report – completions in 2023 are expected to reach the 400,000-unit mark for the first time in over 30 years.

Marcus & Millichap finds that multifamily project starts during February of this year reached the second-highest monthly measure in three decades.

 

Source:  GlobeSt.

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Sale-leaseback deals are offering property owners a stable, long-term solution to restructuring their debt when the lending window for refinancing mortgages has been slammed shut.

Increasingly, sellers are flocking to long-term net lease deals as the first step to cure their balance sheets, using the proceeds from the sale-leaseback to jump-start their debt restructuring, according to a panel of experts at the GlobeSt. Net Lease Spring 2023 conference in NYC this week.

“Sale-leasebacks are uniquely positioned to recapitalize existing mortgage yields,” said Bryan Huber, director of SAB Capital’s Sale-Leaseback Group.

For companies that still want to do deals but find the current cost of debt prohibitive, sale-leasebacks offer a less expensive, alternative form of borrowing that can close faster, the experts said. Sale-leasebacks deals also don’t require back-end balloon payments that often come with traditional financing.

Ross Prindle, global head of Kroll’s Real Estate Advisory Group, said buyers are using their resources, including financing and cash deals, to make sale-leaseback transactions more attractive to sellers by making it less expensive to execute the deals.

“The winners will be [the buyers] who do the best underwriting,” Prindle said.

 

“Eight is the new six in cap rates,” said David Grazioli, president of US Realty Advisors. “The cost to capitalize these rates is making a 20-year deal with 3% bumps look a lot better.”

According to Grazioli, an increasing number of sellers are opting for sale-leaseback deals because they have an urgent need to rehabilitate their cash flow and can’t wait for cap rates to compress again.

However, several experts on our panel warned that buyers must take care to make sure sellers actually are creditworthy before they ink sale-leaseback deals, which are extending to terms as long as 25 years in the current environment.

During Tuesday morning’s State of the Industry roundup session, Gary Baumann, CEO of NJ-based ARCTRUST Properties said the current credit climate is creating opportunities for sale-leaseback transactions.

“Where the credit climate is creating an advantage for all of us now is that it’s opening the window for the sale-leaseback market, larger than it’s been for a long time,” Baumann said. “Because of what’s happening with the banks, we’re seeing opportunities to acquire net leases that weren’t there before.”

On the opening night of our annual Spring Net Lease conference, W. P. Carey announced the largest sale-leaseback transaction in the NYC-based company’s 50-year history, a $468M sale-leaseback of a portfolio of four pharmaceutical R&D and manufacturing campuses in the Greater Toronto Area (GTA).

The portfolio represents the lion’s share of the global operations of Apotex Pharmaceutical Holdings, the largest generic drug manufacturer in Canada.

“This deal would have been a lot tougher to do when there were $200m to $300M CMBS deals available that could close simultaneously,” Gino Sabatini, head of investments at W.P. Carey, said during our sale-leaseback panel discussion.

According to Zachary Pasanen, managing director, investments at W. P. Carey, sellers are flocking to sale-leaseback for a less-expensive cost of capital and extra liquidity during tough times. A sale-leaseback offers a “naturally accretive” alternative funding source, Pasanen told GlobeSt. last month.

Holders of fungible, mission-critical real estate that are willing to sign a long-term lease with market or better rental increases built in can establish an underlying rate that lets them monetize those assets and is inside the going long-term borrowing rate, Pasanen said.

 

Source:  GlobeSt.

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Retail led an unbalanced sales volume month in February for commercial real estate’s asset classes, according to a report last week from Colliers.

Overall, February’s volume totaling $25.1 billion was up nearly 34% from January sales levels, an above-average month-to-month increase.

Retail was the most heavily traded asset class in February, with $9.1 billion of activity, buoyed by the take-private deal of STORES Capital REIT. (Without it, the volume would have been $2 billion, and it would have fallen to a similar extent as other asset classes).

Office volume in commercial and business centers (CBD) was short of the $1 billion mark for the second month in a row – and the first time since 2010.

CBD office cap rates are up 70 basis points over the past year, and MSCI notes pricing is down 2.2%, though “recent cap rate movement would suggest a far more rapid price adjustment.”

Industrial volume got back to where it was in 2015-18 by increasing 63% from January. The STORE Capital REIT deal was the main reason why.

MSCI reported a 4.4% annual drop based on January to February pricing.

Multifamily sales volume is moving downward at a faster pace, with February’s $4.8 billion traded was the lowest monthly total since February 2012. A darling for so long, it is now the third-least-traded asset class for the first time since January 2015.

MSCI’s repeat sale index shows an 8.7% annual price decline, the sharpest of any asset class.

Hospitality sales volume was volatile as it was down 53% compared to last year but up month-over-month.

MSCI reports the strongest price appreciation of any asset class over the past year at 5.4%, and unlike other asset classes, when annualizing monthly statistics, hospitality shows a 2.1% gain on $2 billion in trades for the month.

 

Source:  GlobeSt.

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Less than three weeks after being filed, a bill blocking China and six other “countries of concern” from buying or holding interest in land within range of strategic sites in Florida is heading to the Senate floor.

The Senate Rules Committee voted unanimously to advance the measure (SB 264), a priority of Agriculture Commissioner Wilton Simpson intended to safeguard state security against foreign threats.

Countries named in the legislation — which also includes provisions to protect Floridians’ health information — include China, Cuba, Iran, North Korea, Russia, Syria and Venezuela.

If passed, the bill would ban the governments of those nations and businesses based there from owning real property within 20 miles of “critical infrastructure.” That includes military bases, water treatment facilities, power plants, emergency operation centers, seaports, telecommunication facilities, police stations and other such structures.

Tampa Republican Sen. Jay Collins, a decorated Army Special Forces veteran and the bill’s sponsor, said the measure “does a very good job of protecting our strategic-level interests.”

“We’ve talked about the humanities issues around the world,” he said. “Frankly, there are people who just don’t believe in the American dream and the American way of life.”

As an added layer of protection, Collins’ bill — as well as a House version (HB 1355) by Republican Rep. David Borrero and Democratic Rep. Katherine Waldron — would require documentation from potential buyers attesting their good intent. Any entity purchasing agricultural or real property within 20 miles of a military base or critical infrastructure must provide an affidavit affirming compliance with the proposed law, which would go into effect July 1.

The bill also bars government agencies in Florida from entering into contracts with those seven countries for services that include access to personal information.

Similarly, it would also require health care providers to ensure that the repositories for their patients’ digitally kept records are located within the United States. An amendment the panel approved Wednesday expanded that proviso to also allow storage of that data in U.S. territories and Canada.

Beginning Jan. 1, 2024, any company bidding on government contracts involving access to Floridians’ personal information would have to provide a signed affidavit asserting a foreign country of concern does not own the company or hold a controlling interest in it.

Miami Springs Republican Sen. Bryan Ávila, a lieutenant in the Florida Army National Guard, co-introduced the bill.

According to the U.S. Department of Agriculture, 6.3% of nearly 22 million acres of privately held agricultural land in Florida was foreign-owned in 2021. Senate staff wrote in an analysis that while it is “unclear” how much of that land — roughly 1.4 million acres — belongs to China, “the (federal) department does report that (China) owns 96,975 acres in the ‘South Region,’ which includes Florida.”

SB 264, HB 1355 and a similar but more limited measure (SB 924) Boynton Beach Democratic Sen. Lori Berman filed last month — more than two months after Collins and Borrero announced their legislation — complement an executive order from President Joe Biden. The executive order, which Biden signed Sept. 15, defines additional national security factors the Committee on Foreign Investment in the U.S. must consider when evaluating transactions.

Biden acted in response to growing, bipartisan concern among government officials over protecting Americans’ data, enhancing U.S. supply chain resilience and safeguarding the country’s position as a tech leader.

“The United States’ commitment to open investment is a cornerstone of our economic policy, benefits millions of American workers employed by foreign firms operating in the United States, and helps to maintain our economic and technological edge,” the executive order said.

“However, the United States has long recognized that certain investments in the United States from foreign persons, particularly those from competitor or adversarial nations, can present risks to U.S. national security.”

Isabelle Garbarino, director of legislative affairs for the Florida Department of Agriculture and Consumer Services, signaled support for Collins’ bill Wednesday.

HB 1355 and SB 924 both await a committee hearing.

 

Source:  Florida Politics

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While pricing has widened, early indications in 2023 point to a growing return to confidence for the sale leaseback market, according to a market update report from SLB Capital Advisors.

The report cites “strong credits and robust business models achieving successful processes with large interest from investors”, even in non-core markets, particularly industrial.

Due to the current interest rate environment and companies’ overall cost of capital, the SLB cap rates offer a more attractive cost-of-capital solution than ever, according to the report.

“SLB rates remain well inside of many companies’ WACCs and today, in more cases than not inside companies’ current cost of debt financing, making the sale leaseback an incredibly attractive financing alternative,” it stated.

There continues to be an attractive value arbitrage across various industry sectors driven by the delta between business and real estate multiples. The multiple implied by average SLB cap rates (i.e., 6.25% to 8.25%) implies a multiple of over 12x to 16x.

This compares favorably to general middle market transactions which averaged 6.9x LTM EBITDA for 2022. Attractive arbitrage opportunities are generally prevalent across many middle-market sub-sectors, the report said.

 

Source:  GlobeSt.

 

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In the 2022 US housing report from the National Association of Realtors and Move.com, which operates Realtor.com for the NAR, the big news is more of the same. The market is now, by their count, 6.5 million new single-family homes short of population and household formation growth. For multifamily, that turns into good economic news.

It’s impossible to look at multifamily independent of single-family homes because the two markets are intertwined with household formation. Between 2012 and 2022, there were 15.6 million household formations in the US, according to NAR, with nearly 2.1 million last year.

As formations happen, they need to live someplace, but there aren’t enough traditional single-family homes. During those 10 years between 2012 and 2022, 9.03 million single-family homes were started, with 8.5 million completed. That would be a 7.1-million-unit gap. There were also 4.2 million multifamily unit starts and 3.4 million completions.

The home ownership rate oscillates between about 63% and, at its high point in the fourth quarter of 2004, 69.2%. The current level is 65.9%. That should have meant more like 10.3 million completed single-family homes.

The market gap is where multifamily provides something of a stopgap. As NAR noted, “The gap between single-family home constructions and household formations grew to 6.5 million homes between 2012 and 2022. However, including multi-family home construction reduces this gap to 2.3 million homes.”

However, there weren’t enough multifamily units created to accommodate 34.1% of the housing volume, which would be 5.4 million, far more than the 3.4 million delivered.

This is where the market turns interesting. In 2022, multifamily unit construction increased, “reaching 35.1% of all housing starts by the end of the year, a level not seen since 2015.” That is a rate at which the housing market could begin to catch up and hit a sustainable stride.

Looking at the NAR analysis, over the 10-year period, 340,000 multifamily units were delivered per year on average. A recent research brief from CBRE projected that 716,000 multifamily units will reach the market within the next 24 months, or 358,000 a year, or a roughly 5.2% increase over the baseline. That’s an improvement, but not enough to catch up in the short run.

“If only single-family homes are considered, the rate of housing starts would need to triple to keep up with demand and close the existing 6.5 million home gap in 3 to 4 years” NAR wrote. “However, if the rate of total (multi- & single-family) housing starts increased by 50% from the 2022 rate to an average rate of 2.3 million housing starts per year, a pace of construction on par with what we saw in the early 1970s and some of the peak months for building in the mid-2000s,  it would take between 2 and 3 years to close the existing 2.3 million home gap, assuming the 2012 – 2019 average rate of household formations (~1.3 million households per year).”

One lesson for the multifamily industry to take — supported by the fuller CBRE analysis — is that the housing need is so great, worries about an oversupply overwhelming demand and leading to an undercutting of the market are probably unfounded.

 

Source:  GlobeSt.

 

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What a ride! For the past five years, apartment building owners hit the jackpot with their property values going up nationally by 37%, according to Marcus and Millichap. This was fueled by record rental increases of 13.5% in 2021 and 6.2% in 2022 and mortgage rates hitting their lowest ever in January 2021. But this trend is seemingly slowing. According to CBRE, the average multifamily cap rate went up by 38 basis points to 4.49% in the last quarter of 2022, which means prices are starting to come down. And thank goodness!

As a commercial mortgage banker specializing in multifamily financing nationally, 2022 was an extremely difficult year. It was a head-on collision between property values going up and mortgage rates going up. This produced smaller loan sizes, killing many of our deals. It wasn’t pleasant telling my client, “Sorry, 40% down is no longer going to cut it. Can you come up with 50%?” He replied, “Really? I was only getting a 4% cash-on-cash return, and now you want me to be happy with 2%.” I told him to negotiate the price down with the seller, who opted to take the property off the market instead.

Why Both Buyers And Sellers Have Their Brakes On

Although multifamily is the most sought-after asset class in the commercial real estate market today, prices remain high. This is a result of low supply and demand. In fact, the 4th quarter of 2022 hit the lowest level for both since 2009, according to Moody Analytics.

So, it’s no wonder that both buyers and sellers have their brakes on. Why? Because many buyers can’t figure out what a property is really worth today. Worse yet, they are afraid they are buying at the top of the market with a recession around the corner. And many sellers are in love with those high prices. They know that this is not a good time to sell with rates being so high. I’ve found that most are financially strong and don’t have to sell. They can just wait for rates to come down—snug in the comfort of the very low long-term rates they have on the property.

Why Multifamily Sales Prices Could Come Down Slowly In 2023

The good news for sellers is that the economy seems to be getting stronger, with wages climbing 6.3% for jobs posted on Indeed and 4.8 million jobs created in 2022. Even better, in January 2023, 517,000 new jobs were created, and unemployment hit a 53-year low at 3.4%. Many sellers, real estate brokers and property managers I talk with are arguing that this should justify today’s high multifamily prices and support more rental increases in 2023 as wages have gone up too.

But I think the data from the last quarter of 2022 supports a different argument—that multifamily prices must come down. According to CBRE, new investment in multifamily property fell by 70% (download required). Why? Because investors couldn’t make the numbers work, and the future did not look bright. According to Fannie Mae, there was a negative demand for multifamily units of -103,485 at the end of 2022. Now if we add to this the 783,000 new apartment units they report coming online in 2023, this is a recipe for rents remaining flat and rental concessions on the rise.

Savvy property investors know that if they are going to buy high, they have to raise rents to achieve the return they need in the future. This goes right to their bottom line, raising the net operating income in the income approach of a commercial appraisal and raising property value. But as noted in the report above, Fannie Mae is expecting rents to only achieve a 1.5% increase in 2023.

Today’s high prices just don’t seem sustainable, or I should say, they are not based in reality. The reality is that too many units are available for rent, too many units are coming online and too many renters are already paying more than they can afford with inflation. The reality is what an investor is willing to put down on a loan with today’s high mortgage rates. The reality is that those rates are likely to go higher as the Fed struggles to lower inflation to their benchmark of 2%. It’s at 6.3% now. And the reality is what an investor needs to earn.

A client of mine recently summed it up perfectly: “If I buy at today’s prices, I will be paying what the property will be worth in two years. And that’s if I can raise rents enough. Why would I do that?”

What does all this mean? If you are a multifamily investor, you might be better off waiting until prices come down. I think they will by the last quarter of 2023, as appraisal valuations come down and more sellers must sell due to divorce, partnership breakup, loan maturity or death. Of course, those who have the time may want to make lowball offers on properties with under-market rents in good neighborhoods where renters can afford future rent increases and wait for one to stick.

If you are a seller or listing real estate broker, unless you want to wait for a cash buyer, it’s important to not only sell the property’s upsides and value adds but also think about the buyers’ expectations for earnings. Based on actual net operating income, current interest rates and down payment requirement, what sale price will bring the deal to the closing table?

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

 

Source:  Forbes

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Real estate may not be America’s — or the federal government’s — sweetheart for long.

President Joseph Biden just released a proposed 2024 budget in which he pitched eliminating tax breaks for real estate and private equity firms as part of his efforts to cut the country’s budget deficits by nearly $3 trillion over the next decade.

The White House is aiming to recover about $19 billion by closing the loophole known as the “like-kind exchange,” or 1031 exchange. The loophole lets real estate firms put off paying capital gains taxes from income earned on property sales as long as they make an investment in a similar property elsewhere.

The Biden administration said the real estate industry was the only one getting a “sweetheart deal” from the federal government and equated the tax break to an interest-free loan.

Other items in the budget, such as a 25 percent minimum income tax on the top 0.01 percent of earners, also known as a billionaire’s tax, would also have implications for top real estate executives. Biden also called on Congress to raise the income tax rate from 37 percent to 39.6 percent for people making more than $400,000 and couples pulling in more than $450,000 per year.

Corporations in general could also have an income tax rate of 28 percent, an increase from the 21 percent they currently pay, but still a big reduction from the 35 percent that was expected from corporations before 2017.

“We found that in 2020 when I took office, that 55 major corporations, Fortune 500 companies, paid zero in federal income tax on $40 billion in profit,” Biden said during his remarks. “When I got elected, there were roughly 650 billionaires in America. Now there’s over 1,000. You know how much tax they pay? Three percent. … No billionaire should be paying less than a schoolteacher or a firefighter.”

Biden’s budget instead prioritizes making housing more affordable through programs such as the Neighborhood Homes Tax Credit, which his administration wants to fund with $16 billion over 10 years, and expanding the Low-Income Housing Tax Credit with a $28 billion infusion of funds.

The budget proposal also would set aside $10 billion for planning and housing capital grants for state and local governments to make reforms and streamline building new affordable housing projects on their own. Overall, the budget puts $175 billion toward programs that could facilitate the development and rehabilitation of affordable housing.

Transit in the tri-state region is also a big investment in Biden’s budget. Biden promised about $700 million for construction of the Hudson Tunnel Project — which could stabilize service in the long term on the Northeast Corridor — and $496 million for phase two of the Second Avenue Subway, an opportunity for transit-oriented development

 

Source: Commercial Observer

 

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As they say, if you don’t want the answer, don’t ask the question. But Congress did insist that Federal Reserve Chair Jerome Powell talk about the economy and the Fed’s take this morning. His testimony is probably not what most people want to hear, but certainly what businesspeople, especially in CRE, need to.

If, like an economic Dylan Thomas, you were concerned that the Fed’s policies might go gentle into that good night, don’t worry, they aren’t.

In the testimony, Powell quickly invoked the Fed’s dual mandate of promoting maximum employment and stable prices. Notice, there is no direct mention of easing business costs or supporting asset prices. Those are supposed to come as byproducts — boost business to indirectly promote employment and slow it to moderate prices.

“We have covered a lot of ground, and the full effects of our tightening so far are yet to be felt,” Powell said, for those who want a pause to assess progress. “Even so, we have more work to do. Our policy actions are guided by our dual mandate to promote maximum employment and stable prices. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of labor market conditions that benefit all.”

 

Or, as Oxford Economics translated in an emailed note: “Fed Chair Jerome Powell used his semi-annual testimony to push back against financial markets as his comments were hawkish, noting that the terminal rate for the fed funds rate could be higher than previously anticipated. He noted that he isn’t hesitant to increase the pace of rate hikes if the data on employment and inflation continue to come in stronger than anticipated.”

Although inflation had seemed to be slowing, January was a jarring reminder that inexorable progress toward goals is unusual. Jobs, consumer spending, manufacturing numbers, and inflation “reversed the softening trends that we had seen in the data just a month ago.”

It was the “breadth of the reversal” that meant inflation was running hotter than during the last meeting of the Fed’s Federal Open Market Committee. And even then, the underlying message was not to expect immediate lower interest rates.

Inflation “remains well above the FOMC’s longer-run objective of 2 percent,” and Powell was talking not just the overall number, in which housing costs were a major driver. He specifically mentioned core personal consumption expenditures (PCE) inflation without the volatility of food and energy that push upwards, and core services without housing, which discounts that outlier.

“Although nominal wage gains have slowed somewhat in recent months, they remain above what is consistent with 2 percent inflation and current trends in productivity,” said Powell. “Strong wage growth is good for workers but only if it is not eroded by inflation.”

 

Then he got to interest rates. “We continue to anticipate that ongoing increases in the target range for the federal funds rate will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In addition, we are continuing the process of significantly reducing the size of our balance sheet.”

So, continuation of maybe 25-basis point increases and also continued scaling down of the balance sheet, which means reducing purchases of bonds that help fuel home mortgages and, so, that entire part of the construction and sales ecosystem.

However, the maybe is not to be ignored.

“While a quarter-point increase in the Federal Funds rate is still the most likely outcome of the Federal Reserve’s March meeting, expect the Fed to adopt a half-point increase in March if data on inflation and labor conditions continue to run hotter than expected,” said Marty Green, a principal with mortgage law firm, Polunsky Beitel Green, in an emailed note.

 

Source:  GlobeSt.

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Florida commercial property owners that have been dealing with escalating insurance costs for years are in for more bad news.

This year, insurance rates in the state are expected to go up by 45 percent to 50 percent, and a doubling of premiums won’t be out of the question, according to a new Yardi Matrix report. While coastal regions are most susceptible to hurricane damage, the increases apply to inland areas as well, the report says.

To many Florida real estate owners and insurance industry insiders, the cause is familiar: Hefty payouts from previous weather-related events left carriers insolvent. Most recently, Hurricane Ian ripped through the state’s Gulf Coast last September, and resulted in more than $50 billion in damage, the report says. Plus, some insurers are averse to covering real estate in the high-risk state, altogether. This leaves less competition for carriers that are left in the market, allowing them to raise rates.

Although skyrocketing premiums are a nationwide issue, states exposed to climate change-related risks will feel the most pain. Aside from Florida, the report points to Texas.

“One Texas community with no claims the prior four years and no increase in coverage received a 17 percent premium increase,” Debra Morgan, managing director at Dallas-based advisory, assurance and tax firm CohnReznick, said in the report.

Florida lawmakers have pushed to tackle the insurance crisis for residential real estate. In a special session last December, they made it harder for homeowners to sue insurers, in an aim to entice carriers to return to the state.

But the crisis necessitates lender reform, industry experts argue in the Yardi Matrix report.

Mortgage lenders often require full wind and flood coverage on commercial real estate in flood zones. Also, many financiers tack on a requirement for coverage of business income losses caused by flooding.

Advocates say that properties are often overinsured to cover extreme losses that rarely occur,” writes Paul Fiorilla, author of the Yardi Matrix report.

Danielle Lombardo, chair of New York-based insurance and risk-management advisory firm Lockton Global Real Estate, said in the report that a potential workaround to lenders’ hefty requirements exists. Instead of requiring full coverage, insurance rates could be based on a “true probable maximum loss methodology,” or the maximum possible loss from a catastrophic event.

For example, lenders might require $40 million in coverage for wind damage, even though modeling would show that the maximum loss for the property would be closer to $10 million.

“The premium for $40 million of coverage might be $3.7 million annually, compared to $1 million for $10 million of coverage,” the report says, citing Lombardo. That is “a margin large enough that it could create a delinquency or distress for some properties.”

 

Source:  The Real Deal