Insurance and taxes: Multifamily investors face mounting challenges

In the past 12 months, multifamily investment sales have fallen sharply. Research from CBRE¹ reports that multifamily investment volumes fell 72% in the fourth quarter of 2022, followed by 62% and 71% declines in the first half of 2023. The waning investment appetite is a response to a wide bid-ask spread, driven by a whiplash rise in interest rates that has more than doubled the cost of capital in just over a year. Now, new challenges are mounting. Rising insurance premiums and property taxes are exacerbating already difficult pricing and lending conditions.

Experts on the Investing & Financing in Multifamily panel at the recent Bisnow Multifamily Annual Conference Midwest in Chicago addressed these headwinds as part of a larger conversation about the implications for investing and financing a multifamily deal in today’s environment. Samantha Miller, VP and Mortgage Banker at KeyBank Real Estate Capital^® and one of the speakers on the panel, provided insight into the wide-ranging discussion, which included Samantha Steele, Commissioner of the Second District for Cook County Board of Review; Matthew Katsaros, Principal at Wildwood Investments; Toney Morton, CFO at Redwood Apartment Neighborhoods; and Jim Milliken, BizOps CFP at CliftonLarsonAllen.
 

Rising Insurance Costs and Property Taxes

Extreme weather events in the U.S. cost $165 billion in 2022,² including 18 individual billion-dollar disasters. Climate change comes with a high price tag, particularly for real estate owners. Some insurance companies, like Allstate and State Farm, have decided to pull out of high-risk areas altogether, while others are increasing insurance costs by as much as 60%. Property in California, Colorado, Louisiana and Florida is the most affected. To absorb those costs and the potential for future increased premiums, lenders are underwriting to a 10% increase above the trend line — meaning that if insurance costs on an asset are increasing 30%, the lender will underwrite a 40% increase. That’s a high number for multifamily investors to accept, particularly as rent growth ebbs.

“In general, it is going to be hard to find accretive financing solutions in markets where we are seeing insurance premiums grow. It has increased the barrier to entry in the Sunbelt region, particularly in states like Florida and Texas,” explains Miller. Borrowers are trying to strategize how to absorb insurance costs, particularly on new purchases. Overall, the trend has diminished financing solutions for multifamily deals.

In general, it is going to be hard to find accretive financing solutions in markets where we are seeing insurance premiums grow.

Some regions may see this as a benefit. Rising insurance premiums are pushing capital into new markets. Natural disaster zones have been concentrated in the Sunbelt and Smile states, but insurance costs have remained stable in the Midwest. “It is a great time for Chicago and the Midwest because we are seeing investment flock to markets that aren't seeing a huge uptick in insurance costs,” adds Miller.

Rising property taxes are diminishing investment opportunities in the same way. While the Midwest has been saved from stark increases in insurance premiums, the region has not been exempt from high property taxes. The Midwest is home to some of the country's highest commercial property tax rates, a list topped by Detroit at 4.21% and Chicago at 3.78%.³ “Property taxes represent the biggest hurdle for the city of Chicago,” says Miller. “All you can do is do your homework and talk to local officials to try to get in front of it.” The lending community understands the challenge and remains open to working with borrowers. Miller has also seen some borrowers successfully get a tax reassessment to lower the rate.
 

Lenders Eye Smaller Deals

Overall, the debt markets have shown resilience through a difficult year. Miller observes that there is still liquidity to get deals done, even though market volatility continues to be a challenge. Miller urges borrowers to expedite their transactions. “Time kills deals,” she warns. “If your deal works today, I would advise borrowers to move forward.”

Time kills deals. If your deal works today, I would advise borrowers to move forward.

Lenders continue to exercise caution; particularly, they are scaling back loan size. Today, lenders that were writing $30 million to $50 million loan checks are finding $10 million to $20 million is the sweet spot in the current market. Borrowers are adjusting too. Project leaders are looking for short-term fixed-rate debt in response to rate volatility. “Based on Secured Overnight Financing Rate (SOFR) and the forward curve, I think that people will flock to short-term fixed rate to avoid the cost of SOFR floating rate debt. That will be a trend all year,” says Miller.

On the refinancing side, borrowers are finding more market challenges. Owners with loan terms coming due have relied on banking relationships to supply extension options — but those options are expiring. Over the next year, many borrowers may be forced into a sale. Miller says plenty of dry powder is waiting on the sidelines for a wave of distress — enough capital that most of those deals will eventually find a workable solution. This trend is in its early stages. “We are starting to see the cracks in the surface, but it hasn’t started quite yet,” says Miller.

Acquisitions Market Improves

Despite headwinds, investors are steadfast in pursuing new opportunities, often combing the market for viable deals. “We are starting to see the acquisition market come back, especially in the Midwest, where there is positive leverage,” says Miller. Although investment volumes remain at the lowest level since 2014, excluding 2020 due to the pandemic, multifamily sales inched up in the second quarter, and multifamily continues to make up the majority of commercial real estate deals, representing 35% of the real estate investment market.¹

The buyer-seller gap shows signs of narrowing as sellers come to terms with where the market is today. “The rise in Treasury was hard for people to absorb,” she explains. “I think people were hoping that it would come back down, but a year later, it is still close to 4%. Everyone has accepted the lower return to some degree.” In addition, many borrowers are out of extension options and can’t make their refinances work. That has created more for-sale opportunities and helped buoy the acquisition markets. 

We are starting to see the acquisition market come back, especially in the Midwest, where there is positive leverage.