Credit: Mid-America Apartment Communities

Who says multifamily rent fundamentals are soft? Memphis, Tenn.-based Mid-America Apartment Communities just hit company records for occupancy (95.6 percent) and funds from operations ($29.8 million) for the second quarter, according to earnings released by the REIT on August 5.

Key to Mid-America’s high-performance FFO for 2009—not unlike many multifamily operators—has been cost-containment, particularly when it comes to mitigating rising multifamily property and liability insurance costs. The REIT finalized its 2009 to 2010 property and casualty insurance program renewal with a cost increase of less than 1 percent. “Insurance is our fifth-biggest line item in terms of total costs, so it gets a lot of management focus,” says Mid-America executive vice president and CFO Simon R. C.  Wadsworth. “Cost-containment has been a big part of our program for this year, and we plan actively for renewals with a proactive approach to risk management and a multi-year commitment to our insurance programs.”

Experts like Wadsworth say many multifamily firms—particularly those without risk management units—are not likely to fair as well with renewals this year as property and liability insurance costs continue to increase due to the overall weak economy; the lasting impact of recent large-scale natural disasters in so-called Tier 1 hurricane zones; as well as the increase in distressed and REO (real estate owned) assets within multifamily portfolios. 

“It’s a challenging, inconsistent renewal environment for multifamily owners and operators,” says Kyle Herren, a multifamily specialist for Kansas City, Mo.-based global insurance broker and risk management firm Lockton, which insures approximately 1.5 million multifamily units in the United States. “Owners with assets in Tier 1 locations, with challenging transactions and significant losses, are finding the global insurance marketplace to be inefficient and difficult where outcomes and pricing may vary widely.”

Insurers have been hit as hard by the economy as any other business sector, and the cost of recent natural catastrophes such as fires—$30 billion domestically, according to Herren—puts an additional strain on costs. For multifamily firms that are not concentrating on portfolio improvement via disposition or capital expenditures, or which have taken on distressed assets via acquisition, insurance costs could easily hit $400 to $500 per door or greater, compared to a typical price of $200 per door for well-stabilized and risk-managed portfolios. Unfortunately, that’s the exception, rather than the norm. “Most operators lack a risk manager,” Herren says.

Mid-America has bucked that trend by making risk management a long-term priority in guiding the REIT's portfolio management strategies. “Part of our decision-making in portfolio management is to gradually weed out and sell those assets that have a larger risk profile both from a liability and property insurance standpoint,” says Wadsworth, explaining that Mid-America has passed on certain investment opportunities in Tier 1 sub-markets such as Houston and New Orleans, as well as vacated sub-markets with a perceived unpredictability in the court system. In addition, Mid-America screens all resident’s credit and criminal history backgrounds to keep resident quality standards high.

Operators without a firm grasp of their current resident demographic or the loss-costs of any distressed assets that might seem like exciting acquisition opportunities could be in for a rude awakening when it comes to their next renewal. “You have widespread job losses, and an overall decline in typical tenant quality profiles,” Herren says. “The REO assets coming back on the market have a lot of losses and a lot of capital needs, and with assets trading hands, sometimes the loss history does not come through, and the underwriter needs to take a worst-case mentality. We have a 10,000-unit portfolios right now with $6 million to $8 million in losses."

One bright spot to the insurance sector thus far: a relatively mild hurricane season, which typically does not see a large number of named storms into the month of October. “The capital needs on an already stressed insurance sector are going to increase if the wind starts to blow,” Herren says. “We are really hoping for continued calm in the hurricane season.”