Florida Homeowner Insurance Problems Impact Real Estate
Buckle your seat belts folks the Florida Real Estate market is about to take another hit. Many of my colleagues are and as expected eternally optimistic about the Florida Market but as a consultant we must be more objective.
We base our theory on the following premise; property values all depend on "Rents". Whether we are talking about commercial or residential property the true value of property goes back to RENT. How much on an open and free market will the property bring in rent.
All appraisers are mandated to use three methods in establishing a value of Real Estate, The Comparison sales method, The Depreciation approach and finally income capitalization approach. After doing all three methods the appraisers must "reconcile" the three calculations to establish the value.
Most all of us know the Comparison method, this is what a real estate professional will do to establish a listing value for your property. So if my neighbor's house, which is identical to mine, sold for $250,000 then mine MUST be worth at least that.
Well, maybe!
Private home sales are driven by a lot more than just price, emotion, the neighborhood, the amenities offered by the area, location to malls, transportation just to name a few but, how much can any home command for rent really is the true test.
What if you get transferred and cannot find a buyer how much can you get in rent?
Rent will drive value. Using the "Income Capitalization" method of appraisal the value is based on the following
How much can the property bring in rents (PGI= Potential Gross Income) Say If you had to rent your home it would bring $1,500 per month Subtract any vacancy or collection losses. OK so you had a good year the property rented immediately and none of your tenants checks bounced now you have an EGI (effect Gross Income) of $18,000 per year. But you need to subtract your taxes, insurance and other operating expenses Note your mortgage payment is not a factor in this calculation your result is your NOI , Net operating income OK lets say your taxes are $2,500 and your insurance is $1,200 with a few other miscellaneous expense of $500, your NOI now is $13,800.
Take this number and divide it by the current cap rate. The current capitalization rate is established by evaluating other investments, currently it is about 8%. Take your NOI and divide it by the Cap Rate. 13800/. 08 = $172,500
The value of the property based on Income Cap is $172,500. The problem you paid $250,000. OK in order to cover your mortgage you only need about $1,000 a month you may be able to survive.
Value Drivers
The two factors that drive value are NOI, Net operating income and interest rates. First let's look at interest. Interest rates run converse to value. Using the NOI of the above let's see what happens if interest rates climb to 10.5%. 13800/. 105 = $131,428. The property has not changed, the neighborhood has not changed only interest rate and we see a drop in $41,000 + of value.
The next factor is yet more devastating since the impact is noticeable to the owner immediately that is the loss in NOI. Again let's look at the property value a home now held for rent. You paid $250,000 what is now the value? The neighborhood is great and you have found a person to take a 3 year "Gross lease" at $2,000 per month, assuming the above no collection losses our EGI is $24,000 per year. Now lets take a look at our operating expense. OK $3,000 for taxes (opps you lost your homestead exemption you had when you were living there) and $1,200 for insurance + $500 for miscellaneous :
PGI $24,000
No Collection losses
EGI $24,000
Less:
Tax 3,000
Insurance 1,500
Misc 500
NOI $19,000 / Cap rate 8%
19000/.08 = $237,500
But you say, "Hey I don't care, because I was able to put down 10% it looks like I am ahead of the game because my mortgage is only $ 1,496.93 a Month. (30 Years for an Interest Rate of 7.000 % on a Loan Amount of $ 225,000.00) " With $5000 in other expenses you are at $1913.59 per month and YOU ARE in the black about $86 per month and with your depreciation of about $4,900 per year all is well.
All is well but it is Florida and you receive a noticed from your insurance carrier you are being cancelled your new insurance now is $6,000 per year and the taxes have risen to $3,800 and where are you now?
Mortgage $1,496.93
Insurance 500.00
Taxes 316.00
Misc. 50.00
Out going $2,362.00
In the red $362 per month or $4344 per year
With your depreciation you are just about even.
But your property value?
Insurance now drives values.
Like it or not the insurance Market in Florida has a devastating effect on the value of property? Except for depreciation there is no real reason to make an investment leap in The Florida property market.
I wish I could say relief is in sight but I can't. The biggest property insurer, "Citizens Property Insurance", operated by the state of Florida is about $2,700,000,000 (that is 2.7 BILLION) in the red right now. In this light I can only see increases in insurance rates.
What to do?
We are all impacted some of us more than others. The above illustration is not a made up case rather a real example of a property in my neighborhood that I was interested in but was purchased, fortunately for me, by someone else.
Remember this too shall pass and we will have a robust real estate market again but in the mean time
Investors :
· Invest in vacation properties. - although the increase of $300 per month may preclude someone from renting a property in a long term lease, increases in taxes and insurance can be included in weekly vacation rates. A vacationer will just pay an extra $80 per week and not think much of it.
· Lock in mortgage rates - those of you riding the adjustable rate, stop now.
· If possible buy down your mortgage - give yourself a buffer
· If you have significant equity in the property try to get a credit line against it. _ Don't use it just hold it for an emergency.
· Do not insure personal property at all. This does not work for Condo rentals since the Loss of RENTS, which you dearly need, is tied to your contents. If this is the case DO NOT take replacement cost valuation this will save you a few dollars.
· Max out your property deductibles - a 10% wind deductible may sound like a lot but will save you money . Remember uncovered casualty losses can be deductible.
· Look at lesser forms, folks I can not believe I am suggesting this but Instead of the best landlord policy (known as the DP3) look at the DP2. If the property is newer 1 - 7 years look at the DP 1 (actual cash value adjustments)
· If you are going to acquire property in Florida , go north and center state - buy where that is no one now, trust us you will not be lonely for long.
Real Estate Professionals :
· Don't despair - Learn who to sell Foreclosed property
· Learn to sell investment properties
· Turn your focus north and center
· Market Vacation properties
I wish I could close with a definite time things would turn around but I will say Florida is Florida and it is desirable our market will turn around.