Everything To Know About Commercial Property Insurance

Shanti Ryle

February 19, 2024

The sun reflects off of skyscrapers in a downtown city center

Insuring commercial properties presents a unique set of challenges and considerations. Unlike residential properties, commercial ones encompass a broad spectrum - from office buildings and retail stores to warehouses and industrial facilities, each with specific risks and coverage needs.

Most investors are familiar with homeowners insurance for a primary residence. However, when it comes to commercial properties, the game changes significantly. The risks are different, the coverage needs are expansive, and the policies are complex.

In addition to these complexities, an escalating concern is becoming increasingly hard to ignore: the rising cost of commercial property insurance. This key issue adds another challenge for investors and practitioners in the commercial real estate sector.

This article provides a comprehensive overview of commercial property insurance. From what it covers and doesn't cover to additional coverages to consider, ways to value a commercial property for insurance purposes, and strategies to possibly lower your insurance costs, this post explains it all - without the jargon, straight to the point.

What Commercial Property Insurance Covers

Buildings

The primary focus of commercial property insurance is the physical building or structure. This coverage extends to completed additions, permanently installed fixtures, and even machinery and equipment that are integral to the building. Whether it's damage from a natural disaster or an unexpected fire, the policy covers the cost of repairs or replacement.

Business Personal Property

This includes items like furniture, equipment, stock, and other personal assets used in the business's daily operations. If these items are stolen or damaged due to a covered event, the policy will cover the replacement cost, ensuring your business can continue to function with minimal disruption.

Personal Property of Others

Personal property of others applies to assets your business doesn't own but is responsible for, such as borrowed equipment or a customer's property in your care, custody, or control. The policy protects against potential liabilities arising from damage or loss of these items.

Wildfires dot the California hillsides: fire damage is sometimes excluded from commercial property insurance coverage

What Commercial Property Insurance Does Not Cover

Natural Disasters

Certain natural disasters, such as floods and earthquakes, are typically excluded from standard commercial property insurance policies. These events can cause significant damage, and their coverage often requires additional, specialized insurance policies.

Acts of Terrorism and War

Damages resulting from acts of terrorism, war, or military action are usually not covered under a standard commercial property insurance policy. Coverage for these types of events typically requires a separate policy or endorsement.

Intentional Damage and Normal Wear and Tear

Commercial property insurance does not cover intentional damage caused by the policyholder. Furthermore, normal wear and tear, which refers to the gradual deterioration of property over time due to use and age, is also excluded from the policy.

Specific Policy Endorsements

Certain endorsements can be added to the policy that may exclude specific types of damage. These include Theft Exclusion, ACV Roof Limitations for roofs over ten years old, and Cosmetic Damage Exclusion for purely cosmetic claims, among others.

Given these exclusions, it's paramount to read your policy details meticulously. Look out for Protective Safeguard Endorsements, which necessitate certain protections to be in place and can result in a denial of a claim if the required safeguards are not present.

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Additional Coverages To Consider

Given the diversity of asset classes in commercial real estate and the unique risks associated with each, additional coverage may be necessary to ensure comprehensive protection. Here are some essential add-ons to consider:

Business Interruption Insurance: This coverage compensates for net income, employee payroll, and standard operating expenses when the business is non-operational due to a covered claim. It helps maintain financial stability during downtime.

Equipment Breakdown (Boiler and Machinery) Coverage: While commercial property insurance covers direct physical damage to permanently installed machinery and equipment, it doesn't protect against specific perils related to such machinery. This coverage offers specialized protection against events like explosions, electrical surges, and sudden accidental damage.

Specific Natural Disaster Coverage: Depending on the location and potential risks of a commercial property, an investor may need specific natural disaster coverage, including flood insurance, earthquake insurance, and windstorm/hail insurance.

Ordinance or Law Coverage: If a property is partially damaged and local building codes require demolishing and rebuilding the entire structure, standard insurance may only cover the originally damaged portion. Ordinance or law coverage helps pay for the increased construction cost to meet current building codes.

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Valuing Commercial Property for Insurance Purposes

Replacement Cost

The replacement cost method calculates the cost of replacing the property with a similar one at current market prices. This approach does not consider depreciation, providing coverage for the entire replacement value. It ensures investors can bounce back quickly in the event of a significant loss.

Actual Cash Value (ACV)

The actual cash value (ACV) method considers depreciation, factoring in the property's current condition and age. While this might mean lower premiums, it could also result in less coverage in the event of a loss.

Functional Replacement Cost

The functional replacement cost method considers the cost to replace the property with materials and construction techniques that are functionally equivalent but may differ. This method is often used for properties with unique features or historical significance.

Deductible Types and Amounts

The deductible is the amount a policyholder agrees to pay out-of-pocket towards a loss before the insurance company begins to cover the costs.

Common Deductible Types

There are several common deductible types in commercial property insurance:

Per Building Deductible: This type of deductible resets for each building and each damaging event. It means that there is a separate deductible for each building affected. This type of deductible is suitable for businesses with only one building or multiple buildings located far apart.
Per Occurrence Deductible: This is the total amount the insured is responsible for per event, regardless of the number of buildings damaged. This type of deductible simplifies the process and is recommended for businesses with multiple properties that could be affected by the same event.
Flat Deductibles: These are straightforward deductibles with a specific dollar amount as the deductible. They are easy to understand and calculate.
Percentage Deductibles: These are common for wind and hail risks and are calculated as a percentage of the building value. While they can result in higher out-of-pocket costs for more expensive properties, they ensure the deductible amount is proportionate to the risk level of the property.
Deductible Buy Down Policies: These policies allow businesses to lower the deductible amount by purchasing additional coverage. They can provide peace of mind by reducing out-of-pocket expenses in the event of a claim.

Factors To Consider When Choosing a Deductible Amount

Determining the right deductible amount involves several considerations:

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How Much Does Insurance for Commercial Property Cost?

The cost of commercial property insurance is a growing pain point for the commercial real estate (CRE) market, with some markets witnessing a year-over-year insurance cost growth spiking to over 17% in recent years.

On average, nationally, CRE properties have seen about a 7.6% annual growth rate since 2017, a significant increase compared to the traditional inflation of roughly two to three percent per year, according to Moody's Analytics.

Differences in insurance costs can be observed across various asset classes. Multifamily properties lead the pack with the highest insurance cost growth rates - particularly in Texas, Sunbelt, Northeastern, and California metros - followed by hotels, offices, retail, and industrial properties.

Metros with the highest insurance cost growth rates include Miami, Fort Lauderdale, New York Metro, and San Francisco. Properties in regions prone to natural disasters, such as hurricanes or wildfires, generally have higher insurance premiums.However, this trend of rising insurance costs is prevalent across all asset classes.

How Much Does Insurance for Commercial Property Cost?

Commercial property insurance costs are influenced by diverse factors, ranging from the building's location to its construction type, usage, and installed safety features.

Location

The geographical location of a property plays a significant role in determining the cost of insurance. Buildings located in cities or towns with robust fire protection facilities typically incur less insurance costs compared to those in remote areas or locations with limited fire protection.

Additionally, properties in regions prone to natural disasters like floods, hurricanes, or earthquakes might also have higher insurance costs due to the increased risk.

Construction

The construction materials used in a building directly impact its insurability. Buildings constructed with potentially combustible materials will generally have higher premiums. In contrast, those built with fire-resistant materials could qualify for discounts. Moreover, additions or modifications to an existing structure might affect its fire rating, influencing the insurance cost.

Use of Property

The property's occupancy type also affects its fire rating and, consequently, its insurance cost. For instance, an office building may have lower premiums than a restaurant or auto repair shop because of the different risk levels associated with each type of business. In multi-tenant buildings, one tenant's hazardous operations can negatively impact the fire rating and increase insurance costs for the entire building.

Occupancy Level

Fully occupied properties often attract lower premiums than partially occupied or vacant ones. This is because vacant properties are considered higher risk due to potential vandalism, theft, or undetected damage, like leaks or fires that can escalate without prompt attention. Even a partially occupied building can be considered a higher risk if unoccupied sections are not adequately secured or maintained.

Income Potential

The potential income that the property can generate is another important factor. Properties expected to yield higher income might attract higher premiums because the possible loss of revenue in the event of a disaster could be substantial.

Fire and Theft Protection

The proximity of fire hydrants and fire stations and the presence of fire alarms, sprinkler systems, and security systems can significantly impact insurance costs. Properties with these safety measures typically benefit from reduced insurance premiums due to their decreased risk profile.

Local Regulations and Zoning

Local laws and regulations can also influence commercial property insurance costs. Certain areas have stringent building codes and regulations, which can increase construction and replacement costs. This, in turn, can lead to higher insurance premiums.

Similarly, the property's zoning (whether it's in a commercial, residential, or mixed-use zone) can also impact the insurance cost.

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Understanding Property Limits and Maximum Coverage

Property limits refer to the maximum coverage provided by a commercial property insurance policy. They are critical because they determine an investor's financial protection in the event of property damage or loss.

Here are some tips on determining appropriate property limits:

Consider Replacement Cost: To ensure adequate coverage, the property should ideally be insured at its total replacement cost, including the building and all business personal property.
Evaluate Unique Features: If the property has unique features or materials, these may require additional coverage due to higher replacement costs.
Avoid Underinsurance: Underinsuring the property can lead to coinsurance penalties and potential coverage gaps. It's better to err on the side of over-insurance than to risk being underinsured.
Consider Additional Coverages: Depending on the nature of your business, you may need additional coverages such as business income and extra expenses, equipment breakdown, and ordinance and law coverage to enhance your insurance program.
Evaluate Deductible Types and Amounts: Choose between per building or per occurrence deductibles based on your business's risk tolerance and financial capabilities.
Understand Endorsements and Exclusions: Be aware of any endorsements or exclusions in your insurance policy, such as protective safeguard endorsements, theft exclusions, ACV roof limitations, and cosmetic damage exclusions.
Stay Informed: Keep abreast of factors that may impact insurance rates, such as increasing construction costs and the frequency of natural disasters.
Work with a Knowledgeable Broker: Navigating the property insurance market can be complex. Working with a knowledgeable broker can help you understand policy terms and secure the best coverage at competitive pricing.

How To Lower Commercial Property Insurance Costs

Investors can potentially lower their commercial property insurance costs by considering the following:

Regular Property Maintenance and Updates: Regular maintenance and updates to the property can help prevent damage, thereby reducing claims and lowering premiums. This includes maintaining the roof, plumbing, and electrical systems, among other things.
Increase Deductibles: Agreeing to a higher deductible can lower the insurance premium. However, businesses must ensure they can afford the higher out-of-pocket cost in case of a claim.
Bundling Policies: Many insurance providers offer discounts for bundling multiple insurance policies. Bundling commercial property insurance with other types, such as commercial liability insurance, can save costs.
Implement Fire-Resistant Materials and Techniques: Using fire-resistant materials in the construction or renovation of a property can help reduce insurance premiums. This includes fire-resistant interior walls, floors, and doors.
Choose a Favorable Location: Selecting a location with excellent fire protection and limited risk of weather-related catastrophes can result in lower insurance rates. When choosing a location, investors should consider the region's fire protection facilities and natural disaster history.
Invest in Safety Systems: Investing in safety systems like fire alarms, sprinkler systems, and security systems can significantly lower insurance costs. These systems reduce the risk of significant damage, reducing potential claim amounts.

Downtown construction with smoke from a city fire in the background

The Bottom Line: A Strategic Approach to Commercial Property Insurance

Commercial property insurance is a critical component when investing in CRE. While the landscape of commercial properties varies from office buildings and retail stores to warehouses and industrial facilities, one common thread ties them together - the need for effective insurance coverage.

Throughout this post, we've highlighted the importance of understanding the nuances of commercial property insurance. It isn't a simple extension of residential insurance, but rather a complex field with its own set of risks, coverage needs, and policies. Before purchasing a policy, it's essential to understand the value of commercial properties and their potential risks.

Crexi Intelligence, with its access to over 13 million sales comps and 153 million property records, provides invaluable support for investors. It offers detailed property information, transaction history, ownership details, and interactive maps featuring demographic data and points of interest.

So why wait? Sign up for Crexi Intelligence today and learn more about commercial property values, comps, and trends.

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