The Legacy Of The Los Angeles Fires

The Real Estate Espresso Podcast

The Legacy Of The Los Angeles Fires

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The Legacy Of The Los Angeles Fires

Welcome to the Real Estate Espresso podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce, and on today’s show, we’re talking about the legacy of the latest California wildfires.

Wildfires are not new to California. We’ve seen them in the north and in southern California. There was the Camp fire in northern California back in 2018, the Cedar fire in 2003, and the entire 2020 fire season in which more than four million acres burned throughout California. The unusual Santa Ana winds that come off the mountains are often hurricane force winds that make the spread of fire difficult to contain. The flying embers are virtually impossible to contain, unless you start building entirely out of non-combustible structures and cladding. The spread of these fires is inevitable.

Even traditional fire breaks that would cut a trench of deforested areas are ineffective against the spread of fire in these high wind conditions. The devastation in dense urban areas is hard to fathom. This type of thing is not supposed to happen in places where there’s a fire hydrant on every street corner. As of this writing, even with the help of water bombers from the air, the largest fire, the Palisades Fire, is only 19% contained. Hopefully the winds will die down over the next couple of days, and will give firefighters a chance to finally get ahead of the spread of the fire.

When we look at real estate after a major disaster, there are several effects. Number one, people need a place to live. There’s an immediate, acute shortage of places to live. Those who have a waterfront home, say on the beach in Malibu, often own a second home somewhere else. They’re probably not homeless, so the demand for housing in the immediate area shoots up against limited supply because not everybody has a second home. Pricing shoots up in response to that local supply-demand dynamic. Some people will leave the area. They might go to other parts of California, or they might leave the state altogether.

There have been more than 12000 structures destroyed, and that number’s rising. It’s a huge number, but it’s still a relatively small percentage when you look at the size of L.A. County in its entirety. If they leave California, the most likely destinations are the traditional ones of Arizona, Nevada, Idaho, Colorado, and Texas. Some will seek a location that has a lower incidence of natural disasters. No more fires, hurricanes, earthquakes, or snowstorms, please.

It’s going to take time to rebuild. Some people had their insurance coverage cancelled in the last 30 days by insurance companies that had a crystal ball indicating the higher risk. Reports I’ve seen in the media suggest over 70,000 properties in the area had their insurance policies cancelled by insurance companies very recently. If there was a state component to the insurance plan, some policies had a limit of $3 million in coverage. One beachfront property made headlines where they were only covered up to 3 million insurance and that’s to cover more than $20 million in recent improvements. They’re not the only one. I’ve seen several reports like that.

There’s going to be a shortage of trades in the local area to rebuild that number of properties. Now, some of them, if they didn’t have insurance, they will not get rebuilt, or at least not to the same level. Now, we’re going to probably see a jump in labor pricing. We may also see a surge in construction workers coming into the area, looking to help with the rebuilding process. There were thousands of properties destroyed. But there’s over two and a half million properties in LA County.

I’m not an insurance expert. But I would expect the remainder of these two and a half million properties to be experiencing a surge in fire insurance premiums. In fact, anywhere in the western states, where there’s an area of elevated fire risk, we could see premiums skyrocket. We could see premiums going up in northern California and Oregon and any location that insurance underwriters deem to be at an elevated risk of catastrophic loss due to fire. If we see a doubling or tripling of insurance premiums, much like we did along the Gulf Coast and in Texas, it can change the economics of an income property.

An extra hundred thousand or 300,000 of insurance costs could make the difference between a project that’s profitable versus one that’s experiencing serious negative cash flow. There is a real risk that even though the fire is only impacted 12,000 structures, and I’m saying “only” 12,000 as if that’s not a big number, the impact on the entire market is such that we could experience a large enough increase in operating expense that it will negatively impact property valuations. If you’re not connecting the dots on what I’m saying, let me give you an example.

Let’s imagine for a moment that the insurance cost went up by $100,000 on your apartment project. If all things being equal, you were not able to increase rents to cover that extra hundred thousand dollars in expense. That higher expense has the impact of reducing the net operating income on the property by $100,000. Now let’s say, for example, that the market cap rate for this property is a 5 percent, just to keep the math simple. So a hundred thousand increase in expense would reduce the value of the property by 2 million dollars. Even with this simple example, it’s easy to see how a building that was located far enough away from the fire that it would never catch fire would still experience a negative impact from the fire.

As you think about that, have an awesome rest of your day, go make some great things happen, we’ll talk to you again tomorrow.

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