7 Reasons Why Single Family Rental (SFR) Owner-Operators Should Consider Climate Risk

The single-family rental (SFR) and build-for-rent (BTR) markets are the fastest-growing segment(s) of the U.S. housing market, fueled by rising costs of homeownership, lower household spending power, and favorable demographic trends. Both SFR and BTR provide affordable housing options that shift the burden of homeownership to the owner-operator.

The owner-operator is responsible for major homeownership expenses, including the mortgage, insurance premiums, and repairs, all of which are increasingly sensitive to impacts from climate change. In today’s challenging market, leveraging climate data to better understand how climate risk will not only impact a location but also its residents, will be the difference between a winning and losing single-family rental strategy.

1. Tenant Safety, Health, and Quality of Life

The primary reason why SFR & BTR housing sector should consider climate risk is because it represents a threat to tenant livelihood and quality of life. Acute climate events such as floods, storms, and wildfires pose an immediate threat to safety for tenants and their families. According to the World Meteorological Organization, nearly 12,000 extreme weather, climate and water-related events over the past half-century around the globe that have killed more than 2 million people. In extreme cases, like Hurricane Katrina that struck the Gulf Coast, residents were forced to evacuate and temporarily displaced.

Additionally, extreme weather leads to air quality issues, adversely impacting tenant health. Heatwaves diminish air quality due to stagnant air, the smoke from wildfires contain toxic particulate matter, and storms lead to the growth of mold. Prolonged exposure to heat, wildfire, storm, or flood all lead to respiratory concerns.

Overall, living in an area prone to climate-related risks will cause ongoing stress that will consistently threaten quality of life. By incorporating climate risks into an investment platform, SFR and BTR owners-operators can improve residents’ wellbeing and reduce turnover.

2. Direct Damage from Extreme Weather

Each year extreme weather causes billions of dollars of damage to the real estate industry. In 2021, the world’s largest reinsurer, Munich Re, incurred $120 billion of insurable losses, representing the second most costly year on record. However, insurable losses represent only a small portion of total losses, estimated to be $280 billion, with real estate investors on the hook for the remainder. For single family rental owners-operators, climate volatility represents a threat to net operating income because it results in costly asset repairs that are not always entirely covered by insurance policies.

3. Rising Insurance Costs Eroding Margins

Insurance rates have risen for 22 consecutive quarters, with increases most significant for properties within climate vulnerable states like Florida and Texas. For example, insurance companies hiked premiums for commercial properties in Florida by 15%-30% in 2022, with additional hike rates upwards of 50% expected in 2023. For owners of multifamily properties, including single-family rentals, insurance costs cannot be passed along to the tenants, posing a significant threat to operating margins and liquidity. As depicted in the graph below, insurance expenses are becoming a larger portion of both operating expenses and income. As rent growth slows, or in certain markets turns negative, escalating insurance premiums will erode net operating income.

4. Insurability of Assets

Property insurers are not only increasing premiums, but they’re also reducing the degree of coverage provided. Examples of coverage reductions include lower insured values, exclusions for water damage, and new sub-limits for named storms. In high-risk areas like California, Texas, and Florida, some insurers are outright cancelling non-renewing policies. Since mortgage lenders require high levels of coverage, reduced or no coverage may trigger default, creating a host of new problems for owner-operators with properties in stressed areas.

5. Coastal Market Devaluation

There is growing evidence that climate risk in coastal markets, which are susceptible to storm surges and flooding, has already affected residential real estate prices. More specifically, a 2018 study performed by Pennsylvania State University and the University of Colorado indicated an average 7% “sea-level-rise discount” for non-owner occupied coastal residential properties. Similarly, First Street Foundation released data showing that eight states lost a combined total of $14.1 billion in coastal home value since 2005 due to sea-level-rise flooding. Since rising insurance premiums are challenging the income profile of single-family rentals, value appreciation will represent a larger portion of total returns and should be actively protected.

6. Geographic Concentration in the Sun Belt

Investors measure geographic allocation to ensure that the portfolio is weighted towards more productive regions without over-exposure to any single region. Given current migration patterns to the Sun Belt, a dispropionate share U.S SFR portfolios are located these states. However, a useful extension of geographic concentration analysis is climate risk analysis. For example, NCREIF’s South region is high-risk for extreme heat and hurricanes, which both pose very different threats to a single-family rental portfolio. Therefore, promoting diversification across climate perils (e.g., heat stress, hurricane wind), similar to geographic diversification, can lead to better portfolio performance.

7. FEMA Flood Maps are Insufficient

The scale of FEMA flood maps may not capture fine details of local geography or property-specific factors. This lack of resolution can make it challenging to assess the flood risk accurately for individual properties. Furthermore, FEMA flood maps might not capture smaller-scale flooding events, such as localized heavy rainfall or drainage issues.

Moreover, FEMA flood maps are based on historical data and don’t account for changing climatic conditions. Therefore, over-reliance on FEMA flood maps will result in misleading risk interpretations, especially in areas experiencing more frequent and/or intense weather events due to climate change.

Overall, climate risk represents an important investment consideration for SFR and BTR owners and operators that want to enhance the quality of life of tenants while protecting long-term income and value appreciation. Reach out to our team for more information on how AlphaGeo can help you get ahead of the impacts from climate volatility.

Originally published January 2024