A recession means business collapse and business collapse means empty premises. And that’s when the problems start for property owners and their insurers. Katie Puckett reports on vandalism, theft, arson and a newer menace – cannabis factories.

Squatters? Bring on the dreadlocks and bongos. Graffiti? In every colour of the rainbow. Lead nicked from church roofs? Goodness yes. But even for Graham White, who has seen all this and more in his role as Zurich’s head of property, the current spate of attacks on vacant buildings is unlike anything he has ever experienced.

“It is absolutely destructive,” says White, who is also head of strategic exposure management.

“It is very, very difficult to understand how people can do this to a building. They’ll take anything that’s got a value – live electricity cable, copper gas pipe, things that are essential for the building to function. “They’re not subtle; they don’t cut it out in the way you’d expect a plumber to do it, they just pull it out.”

One of the insurer’s large property owner clients has been struck twice in the past year, racking up £1.5m in damages.

“We’ve had a real increase of unoccupied buildings being attacked and stripped out,” says White. “It’s always been an issue for us and, with the recession, I think it will become a greater feature.”

White is not alone. As prices for scrap metal and commodities soar, insurers across the country are reporting steep rises in the number of properties gutted.

As an insurer of churches and schools, Ecclesiastical knows all about metal theft. A spokesman says: “It has moved beyond petty crime. It is organised crime. Churches in particular have suffered. In 2005 we paid 80 claims costing £300,000. In 2007 we paid 2,200 claims costing £9.2m. In 2008, up until the end of October, we received about 2,200 claims costing £9m.”

As recession hits and businesses fail, their premises are left empty – sitting ducks for metal thieves, arsonists, vandals, squatters and even cannabis farmers. In short, insurers are bracing themselves for a tidal wave of claims.

It is too early to gauge the full effects of the property downturn. The most recent report by property consultant Knight Frank covers the market around the M25 and shows vacancy rates for the third quarter of 2008 rising for the first time in six quarters, with take-up at its lowest level since 2004. But there’s no doubt vacancy rates will rise even further across offices, shops, retail parks and warehouses – and insurers know only too well what is likely to happen.

“Empty property does seem to attract malicious damage, vandalism and arsonists,” says Allister Smith, property risk manager at Norwich Union. “Unless properties are properly secured and managed, that will give rise to increases in damage. Once you start to see a bit of graffiti, it’s normally a downward spiral.”

Smith has noted a rising trend for metal theft, with the perpetrators tearing homes apart and causing up to £500,000 of damage. He’s also concerned about Britain’s high rate of arson. Smith says arson is the cause in about half of all fire-related claims it receives. “It’s always been a major problem in this country.”

Norwich Union has launched a code of practice for property owners to secure and manage their properties and so deter vandals. The code, developed through the Insurers’ Fire Research Strategy Funding Scheme (InFiReS) and the Fire Protection Association, contains an extensive checklist, from disconnecting non-essential services and redirecting mail, to checking fire hoses and accounting for keys.

Claims tend to rise in an economic downturn, so all insurers are putting greater pressure on property owners to take precautions to ward off an attack. Some reduce the cover available for empty properties; others such as RSA maintain full cover across a portfolio, subject to regular inspections by the landlord.

“We need to make sure that while they’re trying to get tenants in, they’re looking after it,” says Chris Withers, customer development director for property investors for RSA.

There is no way to prove a property has been neglected, he adds. “It’s based on trust but, if there’s a claim and we suspect the property hasn’t been well maintained, we would have reason to challenge it. An audit trail of regular inspections would give insurers peace of mind.”

RSA is one of several insurers to team up with a property management company to offer clients a ready vetted inspection service. It was launched in April. “They come and see us and we put them in touch with a third party, a reputable security company. It’s a value-added service alongside cover,” says Withers.

Since August, Norwich Union has also offered a property management service, negotiating a lower rate for clients from Orbis, its preferred supplier.

“They can do everything from putting a building to sleep, to managing it during unoccupancy, to preparing it for new tenants,” says Smith.

“We’ve always surveyed clients’ property and, on occasion, required that certain aspects of fire or security risk are improved or upgraded but, until now, the client had to go away and phone several firms.”

Despite the risks, however, some property owners are reluctant to monitor their premises, says Alex Fudger, director at Andrew Copeland Insurance Consultants in south London.

“It’s amazing when you talk to people who say, ‘Do I have to inspect it?’ If it was my property, I’d be there every day,” he says. “That said, you could get a customer taking every possible precaution and still get broken into.”

Fudger probably has a heightened awareness of the worst that can happen. In recent years, he’s seen his fair share of arson and vandalism cases, but also a worrying rise in squatting and cannabis farming. Squatting is a major problem for local authority housing, but commercial properties can be invaded too.

“Every conceivable type of property will have been squatted – even churches,” he says.

There’s a wealth of guidance on the internet for inexperienced squatters, making them increasingly aware of their rights and what they stand to gain. If they live in a property unchallenged for 10 years, they can apply to claim it as their own.

Squatters are surprisingly difficult to get rid of once they’re in. Not only can they cause considerable damage to property, they may also cost landlords a large sum in legal bills.

“They know not to force entry or change the locks,” says Fudger. “If you report it to police within a short space of time, you should be able to get them out pretty quickly. If not, you’ll have a legal battle. You can’t just go along and grab them by the scruff of the neck and drag them out – you could be arrested for assault.”

Insureds can check whether their legal costs would be covered, but this would not be included in a standard policy.

In recent years, there has also been a sharp rise in the discovery of cannabis factories, perhaps due to greater police awareness and specialist equipment. Police forces now use thermal imaging and similar technology to detect the grow lamps used in these facilities – cannabis not being your average hardy annual.

It’s not only empty properties that may be converted. Even where there’s a model tenant, landlords should be wary.

Fudger is dealing with a case involving a shop supposedly rented to a Chinese herbalist – the farmers clearly appreciate irony. The shop had been converted, basement to roof, into a major cultivation centre, with walls ripped out to allow ventilation and plants stacked floor to ceiling throughout.

The damage to a property can be severe, but Fudger wonders how long it will be before insurers question whether cannabis farming falls into the category of malicious damage. “It’s malicious for a specific purpose. It’s something insurers are going to deliberate over. I was talking to a loss adjuster and he’d had three cases within a month just in the local area.”

Adding to the pressure on property owners is a rule change on tax relief for empty properties – the time limit has been slashed from a year to six months. The cut, which came into force on 1 April, was strongly opposed by property groups but remains in place, even though the market has fallen off a cliff.

“The government argument is that it will encourage landlords to let buildings at cheaper rates,” says Bill Gloyn, chairman of real estate at Aon and president of the City Property Association.

“What it chooses to ignore is that lots of landlords would be delighted to let their properties but, in this downturn, there aren’t tenants who want to take them, no matter how cheap the rents might be.”

Gloyn thinks the tax situation will result in even more vacant properties being left derelict, as landlords don’t have the funds to maintain them properly.

RSA has responded by offering additional cover to landlords, should damage lead to a tenant quitting and the tax being incurred.

“If the tenant breaks their lease and moves away, so the building is unoccupied when it is put back, we will pick up some of the tax,” says Withers.

“Standard loss of rent cover wouldn’t pick up the tax, so we’ve extended our loss of rent cover to incorporate it. It just adds to the pressure on landlords if a property owner has an empty building and no income coming in.”

Withers wrote to customers in February when the product was launched, but admits take-up has been low so far. “It’s not popular yet, we think there’s perhaps a lack of awareness.”

But in the long term, he believes higher vacancy rates are here to stay. “Over the years, there’s less reason for businesses to have premises because more people can work from home and retailers can sell over the internet.”

In the short term, Zurich’s White has embarked on an awareness-raising project of his own – among his younger underwriters.

“Most are under 35 and they’ve not been in a recession before. They know what the requirements are with empty properties, but what they won’t be aware of is how that proliferates.”

What is the true value of property?

You're in Britain, you're at a dinner party – chances are you're talking about property prices. More than likely, you're bewailing how much prices are dropping.
But if you're dining with insurers, loss adjusters or surveyors, the conversation might sound rather different. A building has at least two values – its market price and the amount it would cost to rebuild in the case of fire or other damage. For insurance purposes, this second value is the important one, and it is rising fast as the price of building materials soars around the world.
"A customer should never place any relevance on what he paid for his building," says Malcolm Smith, commercial insurances manager at Groupama. "Actually rebuilding the bricks and mortar is totally unrelated to what the building on the land may be worth. The value of the land in central London means the market value might be twice the rebuilding cost."
"People just don't understand the difference between the two values," agrees Bill Gloyn, chairman of real estate at Aon and president of the City Property Association.
"The market value is dropping and the investment value drops, but the reinstatement cost is going up. Demand for materials in China is very big. It's sucking in steel that might be available to the UK and Europe and that means the price of raw materials is going up."
As a result, many commercial property owners could be insuring their buildings for a lot less than they would cost to rebuild – through ignorance, or perhaps because they are
trying to save money on premiums or professional valuations
as the economy weakens.
But this is one of the worst things they could do. If their building does suffer a claim and it is underinsured, the owners may struggle to find the money to rebuild it themselves, with the potential knock-on effects of loss of rent and harsher taxes on empty buildings.
Norwich Union (NU) has begun a campaign to raise awareness of underinsurance, estimating that as many as half of its clients are underinsured in some form. "As a business,
it's good corporate governance to set the sum insured at the correct level," says Allister Smith, property risk manager.
"It's a false economy to knowingly reduce the sum insured."
NU has started to offer a valuation service for clients, with reduced rates through its own preferred surveyor. Martin Singleton, NU's technical manager in property underwriting, says he targets cases where the sums insured have not moved for several years. "Property owner groups are very good at keeping the sums insured up to date because they employ valuers but, at the smaller to mid end, they might be looking for savings and they don't give it the same priority."
One of the dangers for underinsured owners is the industry-wide practice of "applying average", ensuring that owners only get the cover they have paid for. For example, say a building's reinstatement value is £300,000, but it is insured for only £200,000. If a fire causes £100,000 of damage – one third of the property's true value – the insurer may downgrade the claim to one third of the sum insured, or £66,000. Most insurers will let the owner off if the sum insured is 85% of the true value, or if the owner can prove it has invested in professional valuations.
There's another way owners can be underinsured as reinstatement prices rise more steeply. Typically, they will be insured for the original sum plus a percentage increase on top to account for inflation, historically set at 50%. "A lot of people reduced that down to 30%," says Gloyn.
Inflation can be a much greater burden than property owners might realise, he warns. To give another simplified example, suppose building inflation is running at 7%. "If it takes a year to clear the land and three years to build, after four years, the overall thing could have gone up by 28%. I'm such an old man, I remember the 1970s when we had to review valuations on a quarterly basis because inflation was running at 18%. It certainly needs to be reviewed on an annual basis, even if you don't do a full valuation," says Gloyn.
Of course, insurers and brokers can't do the work of surveyors – all they can do is ask the right questions and point property owners in the right direction. "There's no duty on the insurer to set the sum insured. It's the absolute duty of the insured," says Gloyn. "We may give general advice to a property owner about the need to review the sum insured, but we're not qualified to give any specific advice."