Commercial real estate valuations are built on a straightforward formula. Income minus expenses equals net operating income, and net operating income drives value. For a long time, insurance was viewed as a stable and predictable operating expense. It mattered, but it rarely changed the outcome of the deal. That assumption no longer holds true.
Across the country, property insurance costs have been rising fast enough to materially impact net operating income. In many cases, these increases are quietly reshaping valuations, loan proceeds, and buyer expectations. Because the changes often arrive incrementally at renewal, they can be easy to overlook until a deal no longer pencils.
Insurance is no longer a background expense
Insurance premiums have increased across nearly every major property type, but the real issue is not just higher premiums. Owners are also facing higher deductibles, narrower coverage terms, and stricter underwriting standards. These shifts create operating cost volatility that did not exist a decade ago.
Fannie Mae has highlighted this shift in its multifamily market commentary, noting that insurance costs climbed sharply between 2021 and 2023 as replacement costs rose and carriers reassessed risk exposure. In some markets, annual insurance expenses increased by more than forty percent, turning what was once a manageable line item into a material drag on cash flow. These changes reflect longer term adjustments in how risk is priced rather than temporary market noise, as outlined in Fannie Mae’s multifamily market insights.
For owners and investors, this means insurance can no longer be modeled as a simple annual percentage increase. It now requires the same scrutiny as taxes, utilities, and debt services.
How insurance directly impacts valuation
Commercial real estate values are driven less by what a building looks like and more by how much income it produces. A simple way to think about value is this:
Value = Net Operating Income ÷ Cap Rate
Now let’s put real numbers into it.
Imagine a property producing $1,000,000 in annual NOI.
If the market cap rate is 6%, the value looks like this:
$1,000,000 ÷ 0.06 = $16,666,667
So far, so good.
Now assume insurance premiums and related reserves increase operating expenses by $120,000 per year. Nothing else changes – the same tenants, the same rents, the same occupancy.
New NOI:
$1,000,000 − $120,000 = $880,000
Recalculate the value at the same cap rate:
$880,000 ÷ 0.06 = $14,666,667
That’s a $2,000,000 drop in value caused by a single line-item expense.
What’s important here is that the building didn’t suddenly become worse. The market didn’t soften. The income stream didn’t collapse. The value change happened because higher expenses permanently reduced cash flow, and lower cash flow is magnified in low cap rate environments, where every dollar of NOI carries more weight.
This is why insurance costs are now front and center in:
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Appraisals
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Loan sizing and DSCR calculations
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Buyer pricing and underwriting assumptions
When cap rates are tight, small expense increases don’t just affect annual cash flow, they ripple straight through to value in a very real, very measurable way.
Why insurance costs are rising
Insurance pricing is influenced heavily by geography, construction type, and loss of history, but several national trends are affecting nearly every market.
Climate related events have increased in both frequency and severity, driving larger claims and tighter underwriting. At the same time, construction costs have risen substantially. Higher replacement costs lead directly to higher insured values, which increases premiums even when claims have been limited.
The Federal Reserve Bank of St. Louis has noted that rising operating expenses, including insurance, are contributing to downward pressure on commercial real estate values, particularly in income producing sectors such as multifamily and office. As operating margins tighten, expense volatility becomes a valuation issue rather than just a management concern.These pressures suggest that insurance volatility is becoming a permanent feature of the commercial real estate landscape rather than a short-term disruption.
How rising insurance costs are changing real deals
Insurance is now influencing transactions in tangible ways.
Buyers are increasingly requesting multiple years of insurance history during due diligence rather than relying solely on trailing twelve-month expenses. Many are also asking for forward looking renewal estimates to better understand future exposure.
Lenders are responding by tightening underwriting assumptions. Higher insurance costs reduce net operating income and debt service coverage ratios, which can lead to lower loan proceeds. In some cases, lenders are also requiring insurance escrows or additional reserves, further impacting cash flow.
Over time, these factors begin to influence pricing. Assets in areas with higher insurance volatility or limited carrier availability often trade at wider cap rates compared to similar properties in lower risk locations. The adjustment may be subtle, but it is real.
Underwriting with insurance in mind
As insurance plays a larger role in operating performance, underwriting practices are evolving.
Obtaining an insurance quote during due diligence has become increasingly important. Reviewing deductible structures is equally critical, especially when deductibles are tied to insured value rather than a fixed dollar amount. In a loss of event, those deductibles can represent significant capital exposure.
Stress testing net operating income under multiple insurance scenarios helps investors understand downside risk. Knowing which insurance costs can be passed through to tenants and which remain in the owner’s responsibility is also essential, particularly in retail and office assets.
These considerations are now part of how experienced investors assess asset quality. Building systems, roof condition, and risk mitigation measures affect not only maintenance budgets, but insurability, financing, and long-term value.
Why this matters to today’s investors
Rising insurance costs are no longer just an operational issue. They are a valuation issue. As underwriting becomes more disciplined, investors are reassessing assumptions that once felt safe, a theme we’ve also addressed in What’s Driving Arizona’s Commercial Real Estate Market, where operating costs and risk-adjusted returns are increasingly shaping buyer behavior.
This is why insurance analysis has become part of how the ICRE Investment Team evaluates acquisitions, refinances, and dispositions. By integrating insurance trends directly into underwriting and valuation, investors gain a clearer view of sustainable cash flow and long-term value rather than relying on assumptions that no longer reflect market realities.
In an environment where margins are thinner and certainty matters more, understanding how insurance reshapes net operating income is now essential to making informed commercial real estate decisions.
