With the large number of catastrophic loss events in recent years we have seen insurance companies leaving markets like Florida, and California, and the resulting higher cost of property insurance has become a big drain on NOI and property values for commercial real estate.
Given that property insurance premiums are increasing by as much as 300% in some markets, investors are struggling to determine whether the high cost of insurance is temporarily (and therefore creates a buying opportunity), or whether this is a systemic repricing of risk which will reset property values going forward.
To better understand the dramatic increase in insurance costs we need to dive into the factors that have driven the massive insurance losses of the last few years. Certainly, climate change plays a role in the increased frequency and severity of storms, wildfires, and other weather-related losses. Higher global temperatures are fueling stronger and more frequent storm systems.
Additionally, post pandemic inflation and a sluggish supply chain drove up replacement and repair costs faster than insurance companies could catch up. This is compounded by a systemic shortage of trades labor in the US, which continues to drive up the cost of skilled labor and increases the cost of repairs after a loss event.
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These factors have compounded, resulting in insurance companies underpricing the risk of loss events. This was further complicated by an overly competitive reinsurance market, as a result of the trillions of dollars governments around the world dumped into the economy, flowing through to the investment markets. Today capital in the reinsurance market has all but dried up, as the outflows of capital reimbursing losses has exposed the insurance market to the fact that they had severely underpriced the risk.
Normally the fact that real estate investments are backed by tangible assets is an advantage that protects investors from the volatility seen in intangible assets. However, the risk with tangible assets is that they can be physically damaged or destroyed, and insurance hedges against this risk.
Since insurance hedges the risk of damage or loss for everything – from properties, vehicles, businesses, health care, and almost anything else you can think of – it is insurance that underpins the value of assets, and of the economy as a whole. Material repricing of this risk is a repricing of the entire real economy.
So, where does this leave us? It is tough to say with certainty. Insurance markets have historically been cyclical. Capital tends to flow out when large losses are made, and capital tends to flow back in when large profits are made. And given the increasing premiums that insurance companies are now charging, we would expect their profits to be significant in 2023 (absent any major new catastrophes).
But maybe things are different this time. Climate change appears to be having a profound impact on the level of risk and inflation may be here to stay for a few years yet. There is a good chance that higher insurance costs are here to stay, and that real estate located in coastal markets, or markets with higher catastrophic risk, will see material devaluation due to increased insurance costs.
That being said, demand for housing in coastal markets remains strong as these are still very popular markets and are still experiencing positive net migration.
A dynamic market creates opportunities for the astute buyer. It will be interesting to see how these factors play out over the next few years.
Source: Equity Yield Group AAOA
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Smart, informed people face a unique risk in their investments: getting too “clever” for their own good.
All too often, they succumb to the temptation of trying to time the market, pick individual stocks, or ride the wave of the cryptocurrency du jour. And sometimes it even works—which makes it even harder to avoid next time.
Every time I’ve gotten cute or clever or smug about an investment strategy, it’s come back to bite me. I would like to think I’ve finally eaten enough humble pie to learn my lesson.
So, how do I invest today? Boringly, with wide diversification and small, regular investments like clockwork.
What Is Dollar-Cost Averaging?
Dollar-cost averaging (or DCA for money nerds like me) is the practice of making regular investments in the same broad basket of investments.
Investors most commonly practice DCA with passively managed index funds. For example, they may invest $300 each week in SPY, an index fund that mimics the S&P 500.
The market rises, the market falls, the market throws temper tantrums. You just keep investing through it all, week in and week out.
In the short term, you might lose money if the market dips. But over the long term, you’ll simply earn the average return for that index or sector or whatever you’re investing in. For instance, the S&P 500 has achieved an average annual return of 12.11% over the last 30 years.
Robo-advisors make this particularly easy. I use Charles Schwab’s free robo-advisor, which I set to withdraw money from my checking account every week. It invests the money based on my investment profile settings, spreading money among stocks in all sectors, market caps, and regions of the globe. It even rebalances my account periodically and harvests tax losses.
A human financial advisor could do this for you, too, but they don’t work for free the way some robo-advisors do.
Why Smart Investors Practice Dollar-Cost Averaging
To begin with, dollar-cost averaging ensures that you earn the long-term average return rather than underperforming the market by investing at a market peak or selling at a market low.
I know, I know. You think you’re smarter than everyone else and that you can time the market. So does everyone—and they get burned because of it. As I documented a few weeks ago in the math to becoming a millionaire, the average stock investor dramatically underperforms the market at large.
Dollar-cost averaging also prevents you from trying to get clever by picking individual stocks. You just invest in a broad mix of ETFs to diversify your portfolio across the entire market—or at least a huge swath of it.
Even the smartest, best-informed stock investors are wrong more often than they’re right. It’s why actively managed mutual funds usually underperform the broader market. If these high-paid professionals can’t time the market or pick stocks, you certainly can’t. Dollar-cost averaging saves you from yourself and your bloated ego.
Best of all, dollar-cost averaging is both simple and easy. I spent five minutes setting up my robo-advisor account many years ago. Today, I don’t have to worry about my stock investments at all; they just run on autopilot. In a word, it makes my stock investments completely passive.
How to Practice Dollar-Cost Averaging With Real Estate
Now that I’ve beaten that point to death, it raises a question for us as real estate investors: How can you possibly dollar-cost average real estate investments?
After all, real estate is expensive. Whether you invest in rental properties or passive real estate syndications, each investment requires tens of thousands of dollars. That makes it hard to invest small amounts steadily each month.
Consider these options to dollar-cost average your real estate investments, month in and month out.
Public REITs
Some investors love public REITs. I’m not one of them because they share far too much correlation with the stock market, which largely defeats the purpose of diversifying away from stocks.
But if you like publicly-traded REITs, they offer one of the easiest ways to dollar-cost average your real estate investments. Many REITs trade at $10 to $30 per share, so you can invest in shares every single week if you like.
Private REITs
Some real estate crowdfunding platforms offer private real estate investment trusts. They still pay out 90%-plus of their profits in dividends and often own many properties across the country. They don’t offer the same liquidity as public REITs, but they don’t have the same volatility either.
For a reputable example, check out Fundrise, which allows you to invest with as low as $10, making it easy to invest every week or month. I’ve invested personally in Fundrise, and while it’s had a bad 2023, that’s what markets do: Sometimes they go down.
Property-secured loans
Alternatively, you can invest small amounts in loans secured by real property.
My favorite two platforms for this type of investment are Groundfloor and Concreit. While Groundfloor has a minimum initial account balance of $1,000, you can invest $10 apiece in individual loans.
Every week, my Groundfloor account invests automatically in new loans as they become available. I’ve earned an average long-term return of 9% on these investments, and Groundfloor also offers notes currently paying 6.5% to 10.25% interest.
Concreit works differently, offering a pooled fund that pays 6.5% interest in weekly dividends. You can invest as little as $1 and withdraw your funds at any time.
Again, these simply offer one more way to dollar-cost average real estate investments. But I have thousands of my own dollars invested in both.
Fractional ownership in SFRs
Several platforms have popped up over the last few years that let you invest in fractional shares of single-family rental properties.
My two favorites are Arrived and Ark7. They let you invest between $20 to $100 per share in rental properties, and both offer short-term rentals in addition to classic long-term rentals.
As a fractional owner, you get both rental cash flow and your share of the profits on sale. The tax benefits carry over to you as well.
And yes, I’ve invested personally in properties on both of these platforms as well. I particularly like that Ark7 features a secondary market for selling shares at any time after the initial one-year holding period.
Fractional investing in syndications
Most syndications require a minimum investment of $50,000 to $100,000, which makes them impractical for dollar-cost averaging. That is unless you invest as a member of a real estate investment club, where you all go in on these together.
I know two investment clubs that operate this way, and they each work differently. One is my own company, SparkRental’s Co-Investing Club, where non-accredited investors can invest $5,000 apiece in deals vetted together by the club each month. The other is Left Field Investors, which is more geared toward accredited investors investing $10,000 to $50,000 per deal.
Don’t get me wrong: $5,000 isn’t chump change, and not everyone can invest that much each month. But even if you invest in deals every two or three months, it still offers a way to invest relatively small amounts on a regular basis while targeting the high (15%-plus) returns, cash flow, and tax benefits of passive real estate syndications.
The upshot? I own a fractional interest in thousands of units across dozens of cities, and the total I’ve invested is less than some people invest in a single property.
Boring Performs Better
Sure, it’s fun to brag at cocktail parties that you timed the market perfectly or picked the perfect property or stock investment and beat the market. You get to pat yourself on the back and feel clever—that one time out of five that it actually works out that way. In most cases, you’ll just underperform the market at large.
Aim to be wise rather than clever in your investments. Invest slowly and steadily in stocks and real estate, with small amounts every single week or month rather than occasional large chunks.
This is because investing shouldn’t be “fun” or a hobby unless you’re an active investor who loves renovating properties yourself. Investing should be boring. It should happen in the background, freeing you to enjoy your actual hobbies.
Nowadays, I only invest small amounts in diverse passive investments, exactly as I’ve outlined. And my returns have dramatically improved since I started investing this way.
G. Brian Davis Bigger Pockets
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Most rental owners have not taken advantage of one of the best things the government has ever provided to rental owners – cost segregation. That’s simply because they weren’t informed.
Q: What is cost segregation?
A:
It is an IRS-approved method of accelerating your depreciation and yields approximately $50,000 to $80,000 in cash per million dollars of building value.
Instead of depreciating your property as one unit over 27.5 years (or 39 years for commercial non residential property), cost segregation breaks down your property into its parts and pieces.
To put it into perspective, look at it like a Big Mac. When asked, most people would identify it as a hamburger. Not McDonald’s. To them it is “Two All Beef Patties, Special Sauce, Lettuce, Cheese, Pickles, Onions on a Sesame Seed Bun.” A cost segregation study does the same thing to your building. It separates its components, i.e., the flooring, wallpaper, crown molding/trim, cabinets, counter tops, landscaping, etc.
If you purchased or built a building after September 27, 2017, when the Tax Cuts and Jobs Act came into existence, you are allowed 100% bonus depreciation until January 1, 2023, when it drops to an 80% deduction on any identified personal property assets.
It drops by 20% per year until “bonus” depreciation is gone and it goes back to the original benefits of doing a cost segregation study. So, don’t miss out on using cost segregation on the extra cash benefits.
Assets that can be affected include hundreds of items and represent somewhere between 20-40% of your building that can be expensed, thereby reducing your taxable income.
Q: Shouldn’t my CPA do this?
A:
This is a separate function; cost segregation specialists are not accountants. Cost segregation specialists perform engineering-based studies and work hand in hand with your CPA/ER. When the study is complete, the cost segregation specialist hands off a one-line 481a adjustment for incorporation into your tax filing and should coordinate it with your CPA/ER.
Some tax professionals provide an “accounting study,” which usually only includes obvious items, like rugs and landscaping, whereas cost segregation specialists review hundreds of items including parking lot striping, wallpaper, specialty plumbing and wiring, etc.
Most tax professionals don’t have the expertise to conduct a comprehensive cost segregation study. Their job is to apply thousands of pages of tax code. Cost segregation experts only focus on one aspect of the tax code – cost segregation. They prepare an engineering-based study, which the IRS calls the “certain” method.
Q: Is the cost worth it?
A:
A good cost segregation firm prices each project individually, and it is based on the type of building and the complexity of the project. It is not a cookie cutter one price fits all process. The return on investment typically falls between 10:1 and 20:1.
Before you decide to start the cost segregation study, you will be provided with a return-on investment estimate. A company such as Cost Segregation Services, LLC (CSSI) can provide you with a complimentary analysis, a Net Present Value Schedule, and other materials to help you determine your value in doing a study. It has to be right for you!
A cost segregation study taps into the time value of money because you’re able to depreciate your property faster and take advantage of tax deductions now versus in the future.
QUESTIONS TO ILLUSTRATE THE TIME VALUE OF MONEY:
• If you won the lottery, would you take the payout today or spread it out over 27.5 or 39 years?
• Will you be alive 40 years from now to use future deductions?
• What will your dollar be worth in the future, given inflation? 75¢, 50¢? Isn’t it better to get to use the full value now?
Q: How do I know if my property qualifies for a cost segregation study?
A:
The following requirements must be met for a cost segregation study:
✓ It must be a property that was purchased, constructed, or remodeled/renovated after ’86.
✓ The property’s cost basis must be over $250,000 (renovations $100,000).
✓ It must be a property owned by a for-profit entity (not charities, churches, etc.).
✓ You must have a tax liability or there is no benefit.
The choice can be amazingly simple: keep your money or send it to the IRS. However, you need facts to judge the value of doing a study. CSSI’s predictive analysis will give you those facts so you can weigh your options and do whatever you think is best. You’re a savvy investor and you owe it to yourself to find out how much money is available to you.
TONY BONIFACIC, National Account Representative Cost Segregation Services (800) 344-7671 [email protected]
As a former accountant Tony has been involved as a financial manager, sales manager, administrator, accounts receivable consultant, and trainer for thousands of clients. He has saved millions for his clients including everyone from mom and pops to NYSE companies. In 2007 he began promoting cost segregation to his clients and new contacts. Today he devotes all his time and his representatives’ time to cost segregation.
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