By Grant Chappell
With a rocky election in the rearview, the “stay alive until 25’” mantra in the CRE space, similar to Sam Zell’s “stay alive until 95’” post Savings and Loan Crisis, was too optimistic. Nearly every week we read about more lenders taking back properties after months of “extend and pretend” loan workouts that ultimately resulted in foreclosure. Given the recent tragedies in Southern California with the wildfires, both utility costs and insurance rates are going to increase. While these types of fires are predictable, they ultimately may not be that preventable.
With elevated risk, comes opportunity. As Darwin noted, the species most likely to survive “is that which is most adaptable to change.” As a broker and investor, we try to find inefficiencies in the market and pounce quickly on the right prospects. In my prior article we noted the reset in Oakland apartment values, but have not seen as dramatic a swing in other surrounding cities in large part due to Oakland’s oversupply of new units and declining rents.
For decades, California has been a high-risk state for property insurers due to its geography, climate and regulatory landscape. Wildfires, earthquakes and flooding pose significant risks, making it costly for insurance companies to operate profitably. However, in recent years, starting with major fires in 2017 in Santa Rosa and 2018 in Paradise, we have seen an acceleration of insurers withdrawing from the market or significantly raising premiums.
Strangely, with higher premiums comes higher profits. Progressive Insurance saw their net income climb from $700 million in 2022, to $3.8 billion in 2023 and $8 billion in 2024. Chubb-Limited, an American-Swiss Company, also saw net income double over the same time period from $5.24 billion in 2022 to $10 billion in 2024. While it’s challenging to find direct quotes from the companies, it’s widely known that they’ve cancelled policies in California, Florida and other high-risk states, often citing climate change and weather-related risks.
In 2023 and 2024, major insurance companies, including State Farm and Allstate, announced they would no longer issue new homeowners insurance policies in California. In early February, State Farm reached out to the CA Insurance Commissioner to request an emergency interim rate increase ranging from 15% for condominiums, 22% for houses and 38% for rental units. They claim they have already paid out $1 billion for the LA fires and expect to pay out more this year. Without this increase, they say their capital will be depleted and existing policies in the state may not be sufficient to back the collateral/property on existing policies with a bank involved.
These moves in the insurance industry were driven by the increasing frequency of catastrophic wildfires and the growing cost of rebuilding. The California insurance industry changed in 1988 with the passing of Prop 103. It’s essentially a price control, similar to our local rent control laws, in efforts to keep insurance rates low. As we know, price controls create shortages, and we are quickly witnessing the effects of this policy, despite the good intentions of our elected officials.
As we’ve discussed in this column, older Bay Area apartment buildings have felt premiums triple or more in the last few years with few options as carriers exit the area. Homeowners who can still secure insurance are facing steep premium hikes. According to the California Department of Insurance, average homeowners insurance premiums have risen by over 20% in some regions, with areas at high wildfire risk seeing even higher increases. Some policyholders have reported premium increases of 50% or more in a single year.
This increase in premiums, similar to increase in interest rates since early 2022, should put downward pressure on sales prices. A Business Times article last year discussing the luxury home sales market noted that “There’s a lot of wealth sloshing around the area and contributed to an uptick in luxury sales around the region.” The same can be said for Tech, Biotech and other global industries that create wealth and value locally. Investors who live and work here often want to invest close to home.
The California FAIR Plan, a state-mandated insurer of last resort, has seen an explosion in policy enrollments. Designed to provide basic fire insurance coverage to homeowners who cannot find policies in the private market, the FAIR Plan now covers over 250,000 properties—more than double its enrollment from just a few years ago. However, FAIR Plan policies are more expensive and provide less comprehensive coverage than traditional homeowners insurance. The Palisades fire noted that many owners only had the Fair Plan with State Farm pulling out of the state last year.
While the recent fires will have more impact on homeowners, commercial property owners are also struggling with insurance availability and affordability. Many insurers have either withdrawn from the commercial market or significantly raised rates, making it harder for property owners, businesses and older commercial buildings to secure policies. A vast majority of apartment building policies fall under surplus policies as nearly all major carriers do not write new policies in California on buildings more than 30- to 40-years old.
I reached out to Walt Anderson of Farmer’s Insurance to get his take on the environment. He shares many of the same comments that the main players are going to petition for further increases on homes and the surplus markets will continue to see premiums increase as fewer options are available to commercial property owners. Ultimately, he said the costs of these disasters will be felt by the consumer in high premiums and rents.
Homes in high-risk areas, such as the wildfire-prone regions of Northern California and the coastal zones at risk of flooding, are experiencing declining demand due to the difficulty and cost of securing insurance. In Lake Tahoe, most insurers and HOA’s require tree removal or certain landscaping to minimize fire risk. Remarkably, values have held in Tahoe, though dramatically waned in other mountain areas due to unavailability of insurance.
We’ve seen some real estate deals fall apart due to insurance issues. Buyers who cannot secure adequate coverage may be unable to close on their loans, forcing them to back out of transactions. Older roofs, electrical and plumbing systems are common causes for an insurer to pass on new business. What used to be an afterthought in a deal has now turned into a lengthy and complex approval process that can cause delays in closings.
As traditional insurance becomes less accessible, some homeowners and investors are turning to alternative solutions, such as self-insurance if the property is free and clear or to surplus lines insurers. While these options can be costly and carry a higher risk, it reflects the state of the California insurance market.
As we alluded to earlier, California’s insurance market has a strict rate-setting process, which requires extensive regulatory approval for price increases. In late 2023, Insurance Commissioner Ricardo Lara announced efforts to modernize the system by allowing insurers to use forward-looking catastrophe models to price risk more accurately. Unfortunately this change did not happen in time for the LA fires and many only had the FAIR plan or no policy at all.
The state has mandated expansions to the FAIR Plan to provide broader coverage, but this has raised concerns about the program’s financial stability. Given the FAIR Plan takes on too many high-risk policies without proper financial backing, it will require some sort of bailout, likely by some combination of the State, insurance companies and most existing insurance customers in California. Even with new initiatives to incentivize homeowners to invest in fire-resistant upgrades, such as clearing defensible space, installing fire-resistant roofing, and using ember-resistant vents, it feels like too little too late to make a meaningful impact. Insurers are being encouraged to offer discounts to homeowners who take these measures, though implementation has been slow.
Similar to Sonoma and other pockets of Northern California that were impacted by the fires, LA is likely to impose some form of rent freeze for the foreseeable future. I receive weekly emails from California’s Attorney General Rob Bonta and noted that they are prosecuting two property owners for price gouging on rental homes. It’s tough to fathom such a big loss for LA and how they begin to clean up and rebuild.
I had a chance to ask Tim Warren, another broker with NAI NorCal, about his opinion of Oakland the East Bay in general. He feels this is one of the best times to buy right now as Cap Rates and debt costs are more inline. With more of a return to office policy from the City of Oakland and other local companies, he feels this is a window to buy real estate with day one cashflow at prices we have not seen in years. We’ll look back one day and appreciate the good buy-side opportunities of 2024 and 25.
In the East Bay, investors are finally seeing a bottom in values. The market feels like it’s picked up some steam in terms of traffic at open houses, inbound leads on OM’s and a general sense that the recalls are over and Oakland/Alameda County may be turning a positive corner. In speaking to Nils Ratnathicam, a local investor about the market and how local politics shapes his view, he offered the following:
"The Alameda County apartment market suffered heavily from a political environment that was particularly brutal towards the landlord community. My expectation is the worst is behind us now that there is a new DA, a mayoral election in Oakland in April, and safety (for the foreseeable future) from a Costa Hawkins repeal. That said, every investor in Oakland and Alameda County should be pricing in additional risk when compared to neighboring counties.”
Similar to SF’s recall of Chesa Boudin, Oakland and Alameda County needed new leadership to steer the ship back on course. LA also overwhelmingly voted out George Gascon. These areas are heavy Democrat areas, but the citizens expect better safety and quality of life. The business and investment community played a large role in these outcomes.
When asked from clients about where to invest after selling their properties, we often discuss going out of state. Clearly operating costs on utilities, insurance and maintenance will increase this year. It’s inevitable, especially if we get into tariff and trade wars with Canada, Mexico and China. Furthermore, the threat of deportation of non-citizens could limit the labor for the construction industry, further exacerbating construction costs.
While going out of state is tempting, especially if the client is considering leaving California, it’s always tougher to manage from greater distance. It’s why we still see investors stay local and pay a premium for a good location. UC Berkeley student population increased last year, further helping to absorb all the units in Berkeley. Office buildings in Oakland and the greater Bay Area are going through foreclosure and trading at deep discounts. This will enable new owners to charge lower rents and bring more companies back to the core downtowns of SF and Oakland.
While interest rates remain a concern, we are encouraged by investment activity in Q4 24 and the number of pending sales on the MLS. It’s a sign that more attractive pricing on buildings finally has buyers off of the sidelines. Twenty-twenty-five will be exciting to see increased apartment sales volume and for our clients to find profitable buildings to purchase.
Grant Chappell is principal at NAI NorCal.