For the past 18 months, interest rates have been cited as the primary headwind facing multifamily property owners. However, barring a black swan event, this will change soon, leaving insurance costs—the most persistent aspect of increasing operational expenses—the leading concern for many.
Insurers are raising costs for a number of reasons. Of course, there is inflation, though that appears to be heading in the right direction as the rise in material and labor costs cools off. There is also an increase in third-party litigation funding and higher litigation rates in general, both of which have contributed to a rise in “social inflation” for insurers, resulting in higher costs and tighter coverage requirements.
And then there is the intensification of natural disasters, which is probably the most challenging to address. In 2023 alone, the National Oceanic and Atmospheric Administration recorded 28 “billion-dollar” weather and climate disasters, totaling $92.9 billion in damages and dwarfing the previous high of 22 events recorded in 2020.
At the same time, 41% of the nation’s occupied rental stock (18.2 million units) is located in areas with substantial exposure to weather and climate-related threats. In Florida and California, a shocking 89% and 77% of rental units, respectively, are located in census tracts with at least moderate expected annual economic losses. How our industry addresses this issue will significantly influence when we might return to the historic sub-5% operating cost increases more typical of our business, as well as our ability to invest in and maintain our properties, with particularly acute repercussions for affordable housing.
A Nationwide Problem, With Some Areas Hit Harder Than Others
According to the NMHC, nationwide insurance costs increased 26% year over year from 2022 to 2023. This largely tracks with what we have seen in NewPoint’s own servicing portfolio, with borrower insurance premiums rising 33% on average from 2022 to 2023. Higher-risk geographies brought greater increases. In Florida, for example, premiums rose by an average of 60%, due to what insurers referenced largely as “catastrophic exposure.”
Hurricanes have also destabilized insurance markets in Louisiana and Texas, while wildfires have caused upheavals in California and Colorado. Insurers are either offering major price hikes and reduced coverage or exiting those markets altogether.
Passing these rising costs to the end users in the form of rent inflation is an unfortunate option, but one that is available to market-rate owners. However, affordable housing owners and developers do not have this flexibility because they must adhere to rent caps. As a result, in addition to reducing other operating expenses, they have to make do with less coverage—neither of which is a viable long-term solution. When fixed expenses such as property insurance go up significantly, as they have over the last 24 months, property owners must make choices on what variable expenses to cut to keep their economics close to break even. Payroll as well as repairs and maintenance are the typical expenses where we have seen reductions.
Absent near-term relief, we will lose some of our crucial stock of quality affordable housing as properties sell or may fall into disrepair due to reduced maintenance expenditures. Indeed, the insurance issue has already manifested in the affordable housing development pipeline. Anecdotally, some projects—even those already in the early stages of construction—have been put on hold after insurance costs doubled or tripled from original estimates, making the developments financially unfeasible.
A Starting Point for Solutions
Several strategies exist for swiftly and effectively addressing this challenge. Thankfully, some are already in the works, in large part due to efforts by national real estate associations and nonprofit organizations to raise red flags.
The Department of Housing and Urban Development, for example, recently adjusted guidelines to allow multifamily borrowers to increase the maximum deductibles from $250,000 to $475,000 for wind and storm events. This change, which applies exclusively to new mortgages but could be expanded to include existing loans, effectively reduces premium costs and opens the door to more providers who are increasingly requiring higher deductibles. It should be noted that the counter concern to this approach is whether the sponsor is well-capitalized enough to cover the deductible if the property experienced a significant casualty loss.
While this is a start, given the magnitude of the problem, measures as drastic as the exploration of state- and federal-sponsored risk pools specifically for multifamily and affordable housing assets also merit consideration. Such a program could be modeled off the federal backstop created by the Terrorism Risk Insurance Act, which required insurers to offer commercial insurance for terrorism risk, something they were not previously willing to do.
Alternatively, on a local or regional level, these pools could be funded through a combination of premiums, government and private sector securities, and municipal bonds, as has been done with the Citizens Property Insurance Corp., a nonprofit insurance provider of last resort established by the Florida Legislature in 1993 in the wake of Hurricane Andrew that now has 1.3 million policyholders. While this approach requires further refinement—Gov. Ron DeSantis has suggested that the fund has “not been solvent”—it is nonetheless the right idea and one worth exploring further.
Another promising strategy would be to move some of the insurers’ risk out of the primary market and into the reinsurance market. This could be achieved via innovative risk transfer mechanisms, such as catastrophe bonds (high-yield debt instruments crafted to raise funds for insurers in the event of a natural disaster) and parametric reinsurance (products that provide a predetermined payout based on a specific trigger rather than damages or losses).
In Australia, for example, car dealerships purchase parametric hail insurance, cost-effective coverage only triggered by an event (for example, hailstones greater than 3 centimeters in diameter). Such coverage offers a quick, predictable, and transparent payout, and could be adopted by U.S. insurers, who could obtain parametric reinsurance policies triggered by certain wind speeds, flood levels, or wildfire footprint, with triggers calibrated as needed in various geographies.
Last, under guidance from their federal regulators, lending agencies could work with lender networks to pilot new loan programs that incentivize climate resiliency in housing. We have already seen success in programs that reward borrowers with pricing and underwriting incentives for incorporating energy and/or water efficiencies, self-imposed affordability, or resident health-focused improvements into their properties.
Communities could qualify for such a program by replacing wood-frames with concrete construction in wildfire areas. Building or renovating properties to exceed local wind and wind-borne debris requirements could be the cost of entry in hurricane-prone markets, while, in flood-prone areas, properties could be required to incorporate measures like flood-resistant materials, elevated structures and mechanical systems, and permeable surfaces and bioswales. Properties that meet these benchmarks could receive discounted loan pricing and access to more cost-effective insurance options to offset the increased development costs.
Unfortunately, the dual challenges of rising insurance premiums and loss of access to coverage in specific markets are likely to worsen before they improve. But by starting now to tackle the issues head-on, we can contain the severity and duration of the financial pain felt by property owners nationwide and pave the path for a healthier real estate market down the road.
