Katrina will expose outer limits of insurance policies

The full toll of Hurricane Katrina will take months and probably years to understand and translate into new policies and disaster-recovery plans.

As with most major catastrophes, Hurricane Katrina helped point out a number of weaknesses across many different social, cultural and economic systems.

While government policy makers will grapple with how to adequately address the plight of the poor in the aftermath of a disaster, each industry will focus on its particular weakness that was exposed by Katrina.

For the commercial mortgage industry, the glaring weakness surrounds casualty and condemnation. For lenders, the risk of casualty is supposed to be eliminated through insurance.

When a storm the size of Katrina hits, however, the outer limit of every insurance policy is tested and cracks are exposed.

The end result will be higher scrutiny on policies for borrowers.

As an example of exposing the cracks, there was the story of a $20 million apartment loan that was closed on Tuesday prior to the storm and was deemed insured because the lender had the insurance agent's binder.

The only problem was that when the insurance agent went to place the policy with the insurer, it was Friday, and the storm was bearing down on New Orleans. Reportedly, the insurance company rejected the policy, leaving the property uninsured.

The story's details will probably emerge in a lawsuit, and if they prove to be accurate, we can expect to see further requirements regarding insurance policies so that lenders are not taking on additional risk.

Katrina also had a more immediate impact on commercial mortgage rates. As fear spread among bond investors that oil prices were going to kill the economy, many ran to the safe haven of Treasuries, bringing the yield down.

This helped bring down commercial mortgage rates, which now range from 5.10 percent to 5.25 percent for 5- and 10-year mortgages, according to the Barron's/John B. Levy & Co. National Mortgage Survey.

Low rates have continued to fuel aggressive multifamily and commercial property acquisitions.

One major class of buyers has been the so-called TIC buyers (tenant-in-common). While the trend started on the West Coast and has been lead by Triple Net Properties based in California, there are local ties that are getting stronger. And as rates remain low, this industry should experience dramatic growth.

Louis Rogers, the president of Triple Net Properties, is from local law firm Hirschler Fleischer. Former employees of Cornerstone REIT, which was based here prior to merging with another national REIT, have now put together a venture with Triple Net Properties that will give TIC investors more access to East Coast multifamily properties.

According to Rick Chess, who also had stints at Triple Net Properties and Hirschler Fleischer, there is "$3 billion in the industry -- and it is still largely a cowboy industry."

To his point, very few large brokerage houses sell TIC investments. Chess, who formed James River Research to perform due diligence for TIC buyers, has also joined forces with two local industry veterans to set up a broker/dealer called American Realty Capital Markets. They plan to offer TIC investments to individuals.

Andrew Little is an investment banker with John B. Levy & Co. He can be reached at alittle@jblevyco.com