RISING INSURANCE COSTS AND NEW POLICY LIMITATIONS ERODE
Apartment expenses climbing at twice the pace of rents. Insurance costs are rising at an accelerated rate for commercial real estate, while providers concurrently implement new policy limitations to decrease their exposure. Together, these dynamics are eroding commercial real estate owners' and developers' margins, especially in states with higher environmental risk factors, including Florida, California and Texas. As of June 2023, the average U.S. quarterly apartment premium stood at $180 per unit, translating to a 33 percent year-over-year spike. Following this sizable adjustment, insurance now accounts for more than 8 percent of an owner's quarterly per-unit operating expenses, nearly double the share from five years ago. Factor in rising property taxes and payroll costs, and the expenses associated with apartment ownership rose 9 percent over the past year. At the same time, the national average effective rent rose 4 percent. This disparity and expectations for further operating cost increases and rent growth moderation will broadly influence development proposals, property valuations and investors’ acquisition criteria moving forward.
Developers react by paring back project starts. Spiking insurance premiums, along with elevated labor, materials and financing costs, are making it more difficult for developers to underwrite ground-up developments. This dynamic has the potential to facilitate a broad pullback in U.S. project starts, a trend that already appears to be taking shape. Through the first six months of this year, the value of all commercial starts fell 11 percent, while the number of permits issued for new multifamily projects in June represented the lowest level since late 2020. A slowdown in multifamily groundbreakings, however, appears warranted as the delivery of 400,000 units this year will exceed short-term demand, raising the nation's vacancy rate to a 12-year high of 5.7 percent.
Underwriting and expense concerns favor net-leased assets. The accelerated cost of insurance will alter property valuations, making it more difficult for some investors to underwrite acquisitions moving forward. This dynamic, which could negatively impact localized deal flow, should be most apparent in metros deemed to be at high risk of weather-induced property damage. Heightened insurance costs may also cut into merchant builders’ proceeds when selling a newly-built or pre-stabilized property, as current premiums are significantly higher than what developers underwrote when financing these developments several years ago. Considering these market conditions, an ownership model where the tenant pays for all insurance and property maintenance may represent an appealing investment option for more investors, bolstering the outlook for net-leased transaction activity and sale-leaseback velocity.
The information contained in this report was obtained from sources deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guarantee, express or implied, may be made as to the accuracy or reliability of the information contained herein. Sales data includes transactions sold for $1 million or greater unless otherwise noted. This is not intended to be a forecast of future events and this is not a guaranty regarding a future event. This is not intended to provide specific investment advice and should not be considered as investment advice. Sources: Marcus & Millichap Research Services; CoStar Group, Inc.; U.S. Census Bureau; U.S. Bureau of Labor Statistics; RealPage; U.S. Department of Commerce; Federal Emergency Management Agency; Texas Department of Insurance; Dodge Construction Network; Insurance Information Institute; Quadrant Information Services