The Impact of Runaway Insurance Costs on Multifamily Investment

Elie Rieder

Multifamily residential owners and operators are faced with a myriad of challenges, from supply-chain fueled construction cost increases to inflation-spiked operating expenses and the rising cost of capital for acquisitions and major capital improvements. Most recently, soaring insurance costs are not only causing a ripple effect on rents, but also on the ability of quality owners to acquire and enhance the value of multifamily assets nationwide.

The cost of insurance is not a new issue for multifamily operators, but conditions have worsened in recent years with insurance industry consolidation, increasing claims, carriers departing certain markets, and the ongoing effects of climate change all contributing to higher costs. After property maintenance, insurance costs are one of the leading ongoing expenses for the multifamily owner and operator. In the most climate vulnerable regions of the country affected by wildfires, flooding, hurricanes, and other weather-related events such as California, Texas, and Florida, major insurers are pulling out of markets altogether.

Across the country, insurance companies are reducing offerings in areas vulnerable to climate change-induced floods, storms, and fires, according to the Wall Street Journal, which recently reported that American International Group is limiting insurance sales in approximately 200 high-risk zip codes, including in New York and Florida, after already dialing back new business in California. Meanwhile. Farmers Group has quietly ceased offering new policies in Florida, according to the Journal, citing historically high catastrophe costs and escalating reconstruction expenses. State Farm and Allstate have been scaling back their presence in California, according to the report.

Industry Response

FHS Risk Management indicated, during a National Multifamily Housing Council webinar last month, that hurricanes and flooding cost the insurance industry $120 billion in 2022, one of the costliest years on record. Florida alone accounted for about 80 percent of all property insurance claims nationally, according to FHS, which reported that about 30 insurance carriers in Florida are on regulators’ watchlists right now.

These climate risk regions are now expanding beyond coastal and other traditionally disaster-prone areas, and in transactions already affected by unrealistic seller pricing expectations and a dwindling supply of value-add investment opportunities, transaction volume is slowing considerably. Beyond the cost of operating an apartment property or portfolio, higher insurance premiums are starting to affect property valuations and disrupt transactions with alarming frequency.

NMHC, a trade group representing rental-housing owners and developers, recently found property insurance costs have risen 26 percent on average among respondents during the past year. The higher premiums seen at the start of 2023 came on the heels of Hurricane Ian, a Category 5 hurricane that battered Florida in September, and shook insurance markets in the U.S. with an estimated $60 billion in insured property damage inflicting more than $100 billion in total damages by some estimates.

Even before Hurricane Ian, insurance carriers had not only increased their rates, but also become more selective about where they will insure property, even pulling out of some markets altogether. State Farm Insurance, for example, recently became the latest insurer to exit California, with a decision in late May to stop accepting homeowner, business property, and casualty insurance applications in the area altogether.

The NMHC survey found 61 percent of owners surveyed had to increase their deductibles to maintain affordability in the past three years, while 57 percent reported their insurance carriers included new policy limitations to reduce their exposure. Thirty-four percent said their insurance carriers limited or reduced coverage amounts.

From an acquisitions perspective, recent insurance guidance during the pursuit stage is coming in meaningfully above broker indications. Furthermore, in regard to older assets, it has proven to be a challenge to acquire insurance at any cost in certain markets. In the Northeast, we have been typically underwriting 10-20 percent increases that have not been high enough to kill deals yet. But in markets where climate change risk is peaking, the situation can be more dire.

Natural disasters and the the increasing intensity and frequency of weather events has definitely had an impact on the situation, but what we hear in the field is that reinsurers are continuing to exit certain high-risk markets thus causing rates to skyrocket, and insurance products to disappear completely for older assets. Hopefully, if reinsurers re-enter higher-risk markets, this will bring insurance levels more in-line with recent historical costs.

The New Math

A case in point was a recent property Castle Lanterra was evaluating for acquisition in the North Miami submarket. Built in 1968 with 175-plus units and a retail component, the asset seemed a good fit for our privately held real estate investment company’s focus on repositioning multifamily communities, acquiring quality, older and new-construction properties, and pursuing emerging investment opportunities in strategic growth markets throughout the U.S.

We had underwritten $4,000 per unit for first year coverage—up from the $800 per unit in place currently. However, quotes came in at more than $5,000 per unit for minimal coverage, with which we were not comfortable. Full market coverage most likely would have come in around $8,000 per unit, which we were unprepared to pursue, so we killed the deal in June.

Insurers are getting more stringent in their underwriting requirements, meaning owners and investors need to be more proactive in providing adequate and accurate building replacement costs should a weather event damage their properties, something that in the past was not necessarily enforced by the insurance industry. There has been a huge change on that front this year according to FHS, with everyone now required to directly report adequate insurable rebuilding costs for all buildings, resulting in a profound effect on premiums.

One bright spot, if you can call it that from an acquisitions perspective, is that in cases where sellers are “meeting the market” to reflect the higher insurance costs, a buyer can enjoy a lower price per unit or square foot and, hence, ameliorate value growth over the hold if insurance costs normalize during that time.

On a national level, industry groups like NMHC are talking to policymakers about the impact insurance costs are having on housing investment viability and affordability, and advocating for a reauthorization and reformation of the national flood insurance program, among other measures, including advocating for ways to boost and incentivize greater participation by carriers in the multifamily insurance market and devising ways to bring more capacity to the domestic reinsurance market.

Elie Rieder, CEO, Castle Lanterra