Recipe For Disaster: Extreme Weather, COVID-19, And Rising Construction Costs

Posted by Poppy Behrens on May 4, 2021 12:00:00 AM

Natural disasters, COVID-19, and rising construction costs are proving to be the perfect storm, frustrating owners of new self-storage facilities under construction and those trying to rebuild their businesses following a season of disastrous storms and wildfires in 2020.

This staggering combination of events is causing cost overruns and delays in construction activity for facilities around the country. COVID-19 delayed construction activity and production of building materials early in 2020, as the pandemic shut down operations for months. When things began to recover later in the year, it created a rush to get plans back on the drawing board. Then disaster struck.

Extreme weather, which has precipitated numerous natural disasters around the world in recent times, reared its ugly head in 2020, making it the poster child for extreme conditions. Last year’s historic record of disasters caused $95 billion in losses, according to some estimates.

2020 was a year of piling on with a record number of wildfires, hurricanes, tornados, and hailstorms that caused heartache and financial losses for business owners, residents, and insurance companies.

The National Oceanic and Atmospheric Administration (NOAA) tracked the weather rout over the United States in 2020 and cited 22 separate billion-dollar weather and climate disasters that cost the nation $95 billion in damages. The nearly two dozen disasters shattered the previous annual record of 16 events, which occurred in 2017 and 2011.

Insurance companies bore a heavy burden in losses as a result of natural disasters. In December, Swiss Reinsurance Company, or Swiss Re, reported insured losses from natural catastrophes and man-made disasters totaled $83 billion worldwide in 2020, the fifth-costliest year for the insurance industry since 1970.

Losses from natural disasters accounted for over 90 percent of the total, representing $76 billion in insured losses globally—a 40 percent increase from the year prior.

Wildfires, tornadoes, and a record number of severe storms in the U.S. drove up insured losses considerably. More than 800 wildfires burned close to six million acres across California, Oregon, and Washington in 2020, destroying thousands of structures and producing billions in insured claims, according to PropertyCasualty360.

The number and cost of weather and climate disasters are increasing in the United States due to a combination of increased exposure (i.e., more assets at risk), vulnerability of locations, and the increase in frequency of some types of extreme conditions that lead to billion-dollar disasters.

The average over the past five years has been over 16 events per year, costing approximately $121 billion per year, which is a record loss, according to NOAA.

Even more extreme weather events are predicted for this year. Colorado State University’s 2021 hurricane season outlook predicts an above-average hurricane season. Other experts expect the West’s continuing drought to contribute to even more wildfires in 2021.

Rising Construction Costs

A number of self-storage facilities were damaged by wind, hail, and wildfires last year, and they could be in the cross-hairs of more natural disasters this summer. Facility owners who suffer losses from these threats face a perilous journey in attempting to make their stores whole again.

Recovery starts with an assessment of the damage by insurance adjusters, who work with owners and contractors to get the rebuild started as quickly as possible. However, while the damaged units are out of commission, the operator loses income during reconstruction. And the sight of burned-out buildings is not very inviting to prospective tenants.

But the owner’s suffering is compounded by rising construction costs and delays as contractors chase a limited supply of building materials to meet their schedules.

“Since September of 2020, my steel costs have risen 60 percent,” reports Caesar Wright, president of Mako Steel in Carlsbad, Calif. “In my 30 years in this industry, we are at record highs with steel costs.”

Tarik Williams, vice president of Arizona-based TLW Construction, has his own horror stories to keep him awake at night. Since May, he says costs for light gauge steel framing components have escalated approximately 100 percent.

“To varying degrees, concrete, rebar, and foam insulation have gone up since then. The most painful is in light gauge components,” Williams reports.

It’s a classic case of supply and demand. All real estate classes—not just self-storage—are competing for building materials as well as labor.

“Shockingly, people aren’t running away now—projects aren’t getting stopped or put on hold,” Wright says. “We don’t have clients who are stopping the presses now.”

Jones Lang LaSalle Inc. (JLL), a financial and professional services company specializing in real estate, projects average construction material costs will rise between four percent and six percent during 2021. Last year, supply and demand issues caused by the pandemic led to shortages of some supplies and record increases for some materials.

A 2020 report by Verisk, an advisory and rating organization serving U.S. insurers, indicates that total reconstruction costs, including materials and labor, increased nearly five percent from July 2019 to July 2020.

Residential demand led to a 36.1 percent increase in lumber and plywood costs from December 2019 to December 2020. Copper and brass mill shapes also saw increases up to 20 percent during that period. While steel went up a modest two percent in 2020, lumber saw the most volatility because of production problems in mills.

One contractor reports that plywood has increased four to five times the price of a year earlier. “Lumber went up 135 percent is what a contractor told me,” Wright says. “That is an unfathomable number to me.”

The JLL report states steady cost inflation, which started in the fourth quarter of 2020, has returned this year. Total construction costs rose between 3.5 percent and 5.5 percent every year from 2012 to 2019. JLL projects total construction costs for 2021 should be in that range, possibly even higher. The report also expects the total cost and material cost inflation to be higher than 2019 levels.

A shortage of construction labor, which was a problem before COVID-19, continued last year as contractors had problems finding enough workers to take on new projects. Contractors in boom markets like Reno, Nev., and Austin, Texas, were forced to import workers from outside their immediate areas to meet demand. JLL projects construction labor wages, which rose 2.5 percent in 2020, will be between two percent and five percent this year.

The booming real estate market has created competition for building materials such as steel, which makes up approximately 25 percent of a self-storage facility, according to Wright. These shortages have led to materials rationing in some areas.

“In addition to steel price increases, there has been rationing of steel, so each end purchaser has a certain allotment of steel they’re allowed to buy in a certain timeframe,” Williams says. “Depending on how they manage their backlog on current projects, they could run into situations where they can’t purchase the steel they want for the project they’re doing at that time.”

This inevitably could lead to delays. “Is it impacting the schedule for delivery of materials? Yes,” Williams says.

Balky material deliveries and delays affect the reconstruction of damaged facilities. “Ultimately, the people that are doing insurance construction work are going to be subject to all the same issues that everybody else is dealing with right now in terms of long leads, the delivery of items, costs, and so forth,” Williams notes.

Wright says the steel market is near a 60-day delivery schedule. He estimates a 20,000-square-foot facility in repair used to take three or four months to tear down and rebuild, whereas now it can extend up to five or six months total.

Williams reports that a provider discussed the possibility of doors and hallway systems delivery taking up to 14 weeks. “It used to be you could count on three or four weeks at most for things like that to show up,” Williams says. “So, if any project has not anticipated that kind of a long lead for those purchases, they’re going to be impacted.”

However, skyrocketing prices for materials have not affected all providers uniformly. “I don’t believe that the rising construction costs are having a dramatic impact on renovation or new construction,” says Troy Bix, president of the R3 division of Janus International. “The typical ROI (return on investment) is still outpacing the increased cost. The pent-up demand in small to large markets is high. That being said, we will see how long and how far our industry will go with these dynamics.”

The key to putting a facility together amid the chaos is a matter of teamwork. “One of the big things for insureds is to work as quickly as you can with adjustors and contractors in trying to get prices agreed to so materials can be ordered early in a catastrophic situation or any total loss where you’ve got a fire,” advises Ella Tayrien, vice president of claims for MiniCo Insurance Agency.

“The quicker you get to an agreed price with the contractor and the adjustor, the sooner you’re going to get your repairs made and back in business, and that helps their bottom line too in not losing business and income,” she says.

Reviewing Insurance Limits

With a new storm season pending, it’s wise for facility owners to meet with their insurance agents to assess the current values of their properties and to prepare for the reality of escalating reconstruction costs should disaster strike. Owners who have not reviewed their commercial policy coverage for several years may experience sticker shock if they are forced to make major repairs.

“There’s a very high probability they’re underinsured if they haven’t met with an agent and adjusted accordingly, especially in the last five years given the cost of materials and construction,” says James Appleton, MiniCo’s director of sales for special risk. “Costs go up and you need to account for that and adjust your limits.”

For example, the cost of U.S. billion-dollar disasters from 2016 to 2020 exceeds $600 billion, which is a new record, according to NOAA.

Inflation adjustments in commercial policies are not always automatic, as with homeowner’s coverage, so owners need to be proactive to stay on top of things. The extra premium an owner pays for extended coverage is inexpensive compared to an unexpected reconstruction bill.

“Anytime there’s a catastrophe, you’re always going to run into rising costs and increases in materials, especially this last year,” says MiniCo’s Tayrien. “Coupled with many natural disasters, primarily in Louisiana and other Southern states, and COVID on top of that with delivery issues affected costs significantly.”

Verisk notes in its U.S. Hail Damage Insights that the threat of severe hailstorms now extends well outside of “hail alley” (Colorado, Nebraska, and Wyoming) to include the Midwest, Gulf Coast, Appalachia, and the desert Southwest. In 2020, the states with the most major hail events were Texas, South Dakota, Kansas, Oklahoma, and Nebraska.

Hail events can cause severe damage to self-storage facilities and often result in repairs or replacement of the entire roof or the damaged portions of the roof.

Insurance companies have made adjustments over the years for roof damage. In some cases, insurers will provide replacement cost coverage for a building but exclude or limit wind and hail damage for roofs. Owners can determine the extent of exclusions with their agents.

Property owners should review their coverage with an insurance agent and pay special attention on valuation because it is critical to understand the out-of-pocket exposure they face. Owners can choose limits and deductibles adequate to cover a potential catastrophic loss.

“They should look at their policy each year for wind and hail deductibles in particular,” Tayrien says. “Often insureds have two percent to five percent deductibles, and they can be very high when you’re talking about million-dollar locations.”

MiniCo Insurance Agency offers a wind/hail deductible buy-back program for commercial property that lowers deductibles to as little as one percent or a specific dollar amount and decreases potential out-of-pocket financial exposure.

For premiums between $2,754 and $3,443 annually, depending on the coastal location, owners can reduce their deductibles by $54,000.

“In more difficult areas where there is a higher likelihood of some loss, a deductible buy/back can be very helpful, because for a small premium, you can significantly reduce the deductible,” Appleton says.

“Replacement costs go up every year, and owners should always be looking at their building limits to make sure they have enough,” Tayrien advises. “Plus, any improvements or modifications they make to their facilities need to be taken into consideration for insurance. If they add new buildings or change the quality of materials they are using, those would be different cost factors that they should discuss with their agents to arrive at what the value of buildings should really be.”

Whenever a fire or natural disaster puts a portion of a facility out of commission, the owner suffers a financial loss for every month that the store cannot accommodate paying customers. Owners can mitigate this condition with a business owner’s policy (BOP), which typically provides for loss of income.

MiniCo’s business interruption coverage helps to replace a business’ lost net income that it normally would have earned should an event cause a temporary shutdown of operations. This coverage can be a critical factor in the self-storage facility’s ability to recover from a catastrophic event and continue operations.

MiniCo’s BOP covers business income loss incurred up to 15 months, and extended business income is included up to 180 days beyond the date of repair or replacement. This coverage includes extra expenses.

“In the event of a catastrophic loss, business income insurance is absolutely critical to an operation’s survival,” says Mike Schofield, president and CEO of MiniCo Insurance Agency.

Business income, or business interruption, coverage pays the policyholder for loss of income and expenses following damage to the property resulting in the partial or total suspension of operations.

“Self-storage owners are strongly encouraged to discuss business income coverage with their insurance agents in order to understand its benefits as well as the documentation required to file a claim,” Schofield adds.

No matter when your commercial insurance policy renews, now is the best time to meet with an agent—before severe weather strikes.