Best practices in commercial real estate financing insurance and commercial mortgages in the new world of risk

Glickman, Alexandra; Stein, Joshua B.

doi:10.1002/bref.2

Cited by 1 publication

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“…The findings in Table II are consistent with other work showing that lenders require earthquake insurance for high risk properties (Glickman and Stein (2005)) and that commercial real estate investors purchase earthquake insurance primarily at the request of lenders (Porter et al (2004)). Overall, the results are consistent with the imperfect insurance equilibrium of Result 4.…”

Section: The Effects Of Earthquake Risk On Financing and Pricessupporting

confidence: 88%

Catastrophic Risk and Credit Markets

Garmaise¹,

Moskowitz

2009

The Journal of Finance

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We provide a model of the effects of catastrophic risk on real estate financing and prices and demonstrate that insurance market imperfections can restrict the supply of credit for catastrophesusceptible properties. Using unique micro-level data, we find that earthquake risk decreased commercial real estate loan provision by 22 percent in our California properties in the 1990's. The effects are more severe in African-American neighborhoods. We show that the 1994 Northridge earthquake had only a short-term disruptive effect. Our basic findings are confirmed for hurricane risk, and our model and empirical work have implications for terrorism and political perils. * UCLA Anderson School and Graduate School of Business, University of Chicago and NBER, respectively. We thank Bing Han, Robert Novy-Marx and participants at the Vail Real Estate Research Conference for helpful comments.We thank AIR Worldwide Corporation, Guy Carpenter and COMPS.com for providing data. Moskowitz thanks the Center for Research in Security Prices and the Neubauer Family Faculty Fellowship for financial support. First, markets provide a mechanism through which risk is allocated efficiently. Second, financial markets can serve as a stable source of funding during post-catastrophe periods. Little is known, however, about how well financial markets perform these functions. In this paper, we provide a model of the effects of catastrophe risk on the financing and pricing of properties and find corroborating evidence for the model using unique micro-level data on earthquake risk (the average annual loss due to earthquake damage) and credit. We show that apparent inefficiencies in the supply of catastrophe insurance have a substantial ongoing distortionary effect on credit markets.In particular, our results indicate that earthquake risk reduced the provision of bank financing by approximately 22 percent in California commercial real estate loan markets in the 1990's. We also find, however, that the large 1994 Northridge earthquake affected the market for only about three months following the event. This suggests that while catastrophic risk may not be generally allocated efficiently, the additional distortions caused by even significant catastrophic events are quite short-lived. Our work highlights general features of catastrophic risk markets that are shared by a variety of perils including hurricane, terrorism and political risks. We extend our basic findings to hurricane risk and argue that our results imply that, in the absence of well-functioning insurance markets, terrorism risk is likely to discourage bank financing of properties in high profile U.S. cities and political risk may impede the development of corporate debt markets in emerging economies.Our model examines the potential distortionary effect of catastrophe risk on credit markets. 1 We emphasize that bank financing of catastrophe-susceptible properties is likely to be inefficient for two reasons. First, banks are not expert in assessing or repairing catastrophic damage to p...

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Section: The Effects Of Earthquake Risk On Financing and Pricessupporting

confidence: 88%