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When I made that post of mine in Dec 2000, which I referenced in my last post, I thought we were watching the conclusion of a cycle. We had been experiencing a cycle such as I described in Part One of this article, and we seemed to have bottomed. The housing programs which got started in the late '90s, and then the steady drop in rates from the time of the market crash, had strained the rental industry, but not to the breaking point and, although vacancies had gone up, things were clearly turning around. Through the first part of 2001, the rental business improved steadily.

After 9/11, everything changed. I noticed the impact immediately - and I mean within days. The phone stopped ringing. No appointments to show apartments. No applications. No leases. It showed in a large trail-off of the business in the screening service as well; clearly the problem was at least regional.

Then the layoffs started to hit. Move outs due to loss of job, moving in with relatives. Vacancies shot up. Then more Fed rate cuts to stimulate the economy. More churn on the low end as mortgage rates fell and more people were suddenly able to qualify for a mortgage. Suddenly, the cyclical improvement we had been seeing was aborted, and we were taking another turn around the maypole as pressure on rents increased yet again.

But all of this was relatively superficial. There was a much bigger problem brewing below the surface, and this problem is just starting to surface. I first became aware of the problem less than four months ago - I would never have predicted it - and I am among the early ones affected, just because of where in the calendar my renewals fall.

Now, understand that I am starting to talk in an area where my knowledge is incomplete; much of what I have to say has been given to me by people in the industry and I am just repeating it. I am, though, seeing the effects "up close and personal."

The insurance industry is in big trouble, and this spells disaster for the real estate industry if it is not dealt with very soon. Evidently, the fall of the Twin Towers did enough damage, in aggregate, to wipe out part of the reinsurance industry.

When you purchase insurance, if the insurance carrier decides that their exposure is excessive, they will lay off part of their risk to a reinsurance firm, thereby spreading the risk. The reinsurance is relatively inexpensive since it only comes into play if the damage exceeds some relatively large threshold.

Well, the damage caused by the terrorist attacks evidently was substantial enough that - in the words of one agent I deal with - "several reinsurers were wiped out." I find this to be strange, but this is what he says.

Now, it is also true that insurance companies historically derive considerable portions of their income from their investment portfolios - which curiously enough often includes substantial positions in investment real estate (either directly or through mortgages). The stock market crash has pretty much eliminated that source of income.

Also, over the last several years, claims (mostly fires) from investment properties have been on the rise. Why this would be is out of scope for this post, but I for one am satisfied that this is probably true. The short version is that the average quality of tenant has declined over the last several years as the better tenants buy houses. Poorer quality tenants generally are less responsible in every aspect of their everyday lives, and...well...you do the math. Fire claims are going up.

Another agent I have been dealing with says "State Farm alone lost $600 million last year." Again, I have made no attempt to verify the statement; I just report what I was told.

The upshot is that insurance for investment properties is becoming extremely difficult to obtain at any price and, when it can be found, that price is unaffordable. TMFTom9 reported in his article today that I told him my insurance has gone up 100% on renewal. What he didn't report was that my old policy had $1,000 deductible, replacement cost coverage, with $2 Million liability and included coverage for my five truck, two car fleet. My new policy is up slightly more than 100%, has a five thousand deductible, $500K liability, no vehicle coverage, and coverage on properties that really doesn't meet their actual value although it does meet the mortgage values. Also, there is one property that so far I have been unable to purchase insurance for at any price.

Not only that, I am told it is going to get worse, possibly much worse.

To put it bluntly, I can't afford it. I should also point out that we have a very good risk history; we have two claims in the last twelve years (both fires) and our premiums paid have greatly exceeded the cost of the two claims combined (by a factor of about 5). Also, we have never been successfully sued, and keep good records.

The insurance industry is in trouble. They are hemhorraging money, and becoming very risk averse. Landlords are now being faced with the choice of buying insurance they can't afford and can't pass on as rent increases, or being either "force placed" by mortgage holders or foreclosed on for mortgage violation by those same mortgage holders.

You do the math. And according to all the agents I have spoken with, it is going to get "much worse before it gets better."

If this situation is not brought under control very quickly, the investment property industry will collapse. The industry has been under pressure starting in the late '90s with the new mortage programs. The pressure increased after the market crash as rates fell quickly, and then the recovery of 2001 was aborted by 9/11. And now, there is a massive cost shock just starting to work through the industry, at a time when much of the industry is short of cash and struggling with cash flow.

In my next post, I'll talk a bit about what I see as the implications of all of this.
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