The risk of undervaluing a commercial property, in the context of insurance, is clear.
Businesses end up buying insufficient insurance that doesn’t cover the cost if they have a total loss and need to totally rebuild. Likewise, the providing insurer would not be receiving an appropriate rate of premium for the exposure it’s taking on.
But, what are the risks of overvaluing commercial property?
It’s a question that is particularly relevant right now, following the announcement by the European Systemic Risk Board (ESRB) that commercial property in most EU countries is showing signs of overvaluation.
The price surge in commercial property is resulting from “high investor demand and the search for higher yield”, according to the ESRB, which is responsible for maintaining financial stability in the EU.
Above: Photo by Randy Colas
Yield-starved investors are piling money into property, The Times reports, opening them up to excessive risk-taking. Commercial properties like offices appeal to investors because of their high liquidity and being relatively easy to manage.
The announcement from the ESRB follows a warning from the European Central Bank (ECB) that commercial real estate values and transactions were nearing levels not seen since before the financial crash.
In its report, the ESRB said the combination of positive house price dynamics and overvaluation “could generate losses for banks and other financial intermediaries involved in real estate financing should the real estate market experience a significant downturn.”
However, the difference now, compared to 2008, is that the property values are being driven up by investor demand rather than by extreme levels of property-backed lending. In fact, the ESRB report notes that “bank credit for commercial real estate has been muted”. So, any caps on lending enforced by the ECB are unlikely to address the issue.
The issue of overvalued commercial properties looks set to remain for the foreseeable – especially with the ECB preparing a fresh round of stimulus, which will likely drive up prices even further.
So, how does this overvaluation impact on Property & Casualty Insurance in the EU?