Lenders Forcing Landlords To Swallow Higher Insurance Coverage Or Face Distress

Commercial real estate distress has been on the rise as more property owners struggle to stay current with their loans. But the rising cost of insurance is adding a new threat for small landlords: having coverage forced on them by their lenders.

Insurance brokers and lenders expect to see more borrowers be subject to force-placed insurance — also known as collateral-protection, creditor-placed or lender-placed insurance — which is used by lenders to safeguard their investment when a borrower’s coverage lapses or doesn’t meet their requirements.

Force-placed insurance can be up to 10 times more expensive than coverage bought on the open market, blowing open the budgets of smaller owners, in particular, with less margin for error on their loans. 

“It's a real serious situation that as a commercial business you want to avoid,” said Mark Friedlander, senior director of media relations at the Insurance Information Institute. “I mean, realistically, they’re going to default on their loan.”

Lenders can stick borrowers with force-placed insurance if they have a lapse in or insufficient coverage, don't purchase or — most commonly — fail to provide proof of insurance, said Danielle Lombardo, managing director and chair of the real estate, hospitality and leisure division at WTW.

If a borrower has insufficient insurance, then the collateral backing a lender's investment is more exposed to natural disasters or other property damage. Force-placed covers the balance of the loan and typically protects against fire and wind damage, as well as equipment the borrower failed to insure. The cost is added to the loan, driving up monthly payments.

“Our goal is to have them be able to get the right insurance product for them that protects them, protects us and is at the right price,” Centennial Bank Southeast Florida President J.C. de Ona said. “But of course, sometimes you have circumstances that you don't have that at the time.”

During periods of widespread financial distress, force-placed insurance tends to surge, said Martin Zilber, a partner at Krinzman Huss Lubetsky Feldman & Hotte. Amid the Great Recession, waves of foreclosures and loan defaults drove a rise in force-placed policies in both residential and commercial properties, he said. 

Foreclosures and defaults are rising again. By the end of 2024, more than 10% of all commercial real estate properties backed by a CMBS loan were in some form of distress, according to CRE data firm Cred iQ. The delinquency rate of CRE loans held by U.S. banks has nearly tripled since 2022, according to the Federal Reserve Bank of St. Louis.

“Force-placed is going to become a bigger problem if and when there's a downturn,” said Zilber, an insurance litigator and former Florida circuit court judge. “And look, rising insurance costs and things like that can lead to a downturn in the real estate market.”

The average cost to insure an apartment increased by 132% in 2023 compared to the 15-year prepandemic average, according to a Moody's analysis. Average commercial property insurance costs grew by roughly 10% a year between 2017 and 2023. 

Property owners might budget for a fixed monthly payment that includes taxes and insurance, but sudden jumps in premiums, driven by hurricanes or historical damage risk, can disrupt that plan, Zilber said.

It’s a dangerous balance.

“It could force you into bankruptcy,” Zilber said. “Certainly, the fact that rising insurance or lack of insurance coverage availability is a problem.”

While elevated premiums don’t directly trigger force-placed insurance, they could add financial strain on borrowers that are already stretched thin. De Ona said he has witnessed force-placed insurance becoming increasingly common over the last few years for this reason.

He added that market-rate insurance has become so expensive that some of Centennial Bank's borrowers have kept their force-placed insurance because it was cheaper than what they could buy on their own.

He said none of his borrowers have been pushed into foreclosure because of force-placed insurance, but it isn't off the table.

“For banks, it becomes problematic because if the borrower takes force-placed and they can't pay it, then you start adding the premiums to the loan balance,” de Ona said. “So, it starts becoming a problem for the bank as far as the loan goes.”

Force-placed insurance can also be placed on borrowers with securitized loans. A Morningstar Credit analysis of CMBS loans found two dozen properties that have been placed on watchlists or moved to special servicing with force-placed insurance. The properties are on the smaller side and spread among Florida, Texas, New York, New Jersey and Arizona.

Payments on the loan tied to the Z Ocean Hotel in Miami Beach quadrupled last year because the debt servicer put force-placed insurance on the property, according to commentary in the Morningstar Credit database. The borrower, Louis Taic, fell behind on mortgage payments shortly thereafter but is now in talks to resolve the issue.

“The borrower failed to place the insurance coverage required under the loan agreement, leading the master servicer to force-place insurance,” special servicer Argentic Services Co. wrote in loan commentary last month. “A default notice has been issued, and the borrower has stated its intent to resolve the insurance defaults.”

Bisnow was unable to reach Taic for comment.

The loan at 44 Whippany Road, a 231K SF office building in Morristown, New Jersey, was transferred to special servicing in February after its master servicer watchlisted the debt for force-placed insurance. The borrower owed more than $183K for force-placed insurance as of January, and as of March, the loan was more than 60 days delinquent, according to Morningstar.

The building's owner, New York-based Opal Holdings, didn't respond to Bisnow’s request for comment.

While it depends on the contract, lenders are legally mandated to give at least 45 days' notice before force-placed is implemented. Borrowers have another 15 days after that to find market-rate coverage that falls in line with a lender's requirements, according to the Consumer Financial Protection Bureau.

“Typically, they'll run around and try to get the insurance compliant, and then they end up getting out of the force-place insurance program,” Lombardo said.

For lenders, proactively protecting their investments is the priority. Centennial Bank pulls reports daily, and when insurance is about to expire without a new plan in place, the bankers step in.

“If we see that we haven't received insurance for whatever reason, we're contacting the borrower and we're having a discussion with them,” de Ona said. “Sometimes we learn at that point that they're having issues obtaining insurance.” 

While the exact reasons properties are struggling to maintain or find insurance aren’t always clear, it is more common for smaller borrowers to be more vulnerable to these challenges, Lombardo said.

“They're not going to have the leverage of a large portfolio to purchase the insurance that they need,” Lombardo said.

Among the challenges of rising premiums, force-placed insurance is on the “periphery,” she added.

But with rising costs squeezing borrowers, insurance has become another financial strain for property owners already juggling inflation and high interest rates. Force-placed insurance just adds another headache — for lenders and borrowers alike.

“Most of the time, banks don't want to have properties that are not insured or have a bunch of clients that are getting force-placed,” de Ona said. “I don't think that that's a strategy for a bank. I think they want to help and work with the client. I think it's the right thing to do.”