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S&P Global Rating Actions In 2023 Reflect Stability

Military housing bond ratings are among the strongest in the public finance rental housing sector:

• 'AA' or 'A' category: 86% of public ratings.
• All but one of the 92 public ratings are rated in the 'BBB' category or higher.
• An overwhelming majority, or 98% of public ratings, carry a stable outlook, with the remaining 2% on positive outlook.

In 2023, we affirmed 24 of our outstanding ratings, raised 11 ratings, and lowered one rating. Our only downgraded issuer, Corvias Military Living LLC's (CML) series 2010 certificates issued for Fort Sill, was due to our view of declining cash flow, but we subsequently raised the rating on receipt of updated information detailing extraordinary one-time operating expenses that were covered from funds outside of the project's cash-flow. Upgrades primarily reflected BAH growth and occupancy improvement, leading to stronger financial profiles.

Consistent BAH Rate Increases Support Project Revenues

The BAH, a component of compensation for service members of the U.S. Military, support projects in the form of predicable and stable revenue trends. The Department of Defense's (DoD) budget line-item for BAH, the primary source of revenue for the projects we rate, steadily increased by about 5.3% annually on average from 2021 to 2023. In late 2023, DoD announced that BAH rates will again increase substantially in 2024, providing projects with additional financial buffer, which we think will lead to another year of stability in the military housing sector.

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Chart 2

Resilient Occupancy And Demand

Occupancy over the three years ended June 30, 2023, ranged from 93.1% to 93.4% across our rated universe, mostly stemming from solid demand for family units on base and, typically, a lack of affordable units off base. Stable occupancy year-over-year, coupled with increasing BAH rates, have underpinned healthy operating results for most of our rated projects.

Exceptions to the overall trend are what we view as base-specific issues:

• Fort Eisenhower Housing LLC (formerly Fort Gordon). Occupancy through fiscal 2022 significantly deteriorated from several factors, including: fallout from recent media reports and federal oversight actions, a competitive rental market, and a large renovation project that will take as many as 238 units off-line during construction. (See "Fort Eisenhower Housing LLC, Georgia; Military Housing," published Dec. 15, 2023).
• New Orleans Navy Housing LLC. Occupancy through fiscal 2022 declined from the previous year as a result of significant hurricane damage that displaced residents. Year-to-date fiscal 2023 physical occupancy increased to 85.94% from 78.78%, according to rent rolls, as it completes the necessary property renovations. (See "New Orleans Navy Housing LLC; Military Housing," published July 26, 2023).

U.S. Military Personnel Levels Trend Negatively

One trend that could disrupt the sector's stability is continued decline in domestic active-duty personnel. Between 2020 to 2023, the number of U.S. based service members decreased by 5.1%, or a total of more than 52,000 personnel. The DoD has struggled to reach its enlistment goals in the post pandemic era, as the Army, Navy, and Air Force all fell short of their recruiting targets for 2023. According to the U.S. Army recruiting command, recruitment is down due to a variety of factors, including the tight U.S. labor market, lack of military service awareness, and declining physical and mental fitness among potential recruits, typically young adults between the ages of 18 and 24. While the military housing projects that S&P Global Ratings rates serves only a fraction of the population at a given installation, continued declines in enlistment could lower demand for military housing in the medium to long term.

Chart 3

Rising Expenditures May Pressure Projects With Already Narrow Margins

While operating incomes at privatized military projects are stable overall, we have observed increasing expenses from maintenance and repair, utilities, and insurance.

Renovations and repairs

Many rated privatized military housing projects have been in operation for 20 or more years, resulting in significant needs for upgrades and renovations to remain competitive with off-base options. From fiscal 2021 to 2022, overall maintenance and repair costs jumped 7.5% due to inflationary pressures on building materials, labor shortages, the growing needs of aging housing stock, and enhanced resiliency upgrades for projects exposed to extreme weather conditions. Our analysis of maintenance and repair expense is adjusted for both deposits into the project's Capital Repair and Replacement fund (CRR) and capital expenses funded through the account. Average maintenance and repair per unit in fiscal 2022 was about $363, an increase from $337 in fiscal 2021. While fiscal years 2023 and 2024 totals are unavailable as of the date of this article, we expect maintenance and repair costs to remain high as projects continue delivering necessary renovation and repair in a higher cost environment.

Legislation restricting additional debt issuance secured by military housing properties has led some owners to take a financing approach where surplus cash flow or residual revenue from mature military housing projects are securitized to fund longer term capital repair and renovation expenditures. Excess cash flow from multiple military housing developments are collected and cross-collateralized for debt service payments, while bond proceeds fund capital reinvestments at the military housing developments. In our view, these debt funded renovations and repairs could improve the quality of the properties while also reducing annual repair expenses. (See "MMH Master LLC, NJ Series 2024A Military Housing Project Class I Bonds Rated ‘BBB+’; Outlook Is Stable," published Feb. 16, 2024.)

Utility costs

Geopolitical tension and inflation spiked commodity prices resulting in utility costs increasing 12.1% in fiscal 2022. Although costs declined somewhat in fiscal 2023 as oil and natural gas prices fell, a resurgence of some supply chain bottlenecks and conflicts in energy producing regions could reverse the improving trends observed in 2023.

Insurance

After a sharp one-year increase of 29.2% in fiscal 2021, the average insurance expense from our rated projects decreased by 2.1% in 2022. However, this modest decrease follows several years of compounding material increases. Given the sustained increase in insurance premiums and the expectation that these costs will continue escalating, some military housing operators have either chosen to, or were required to, implement self-insurance. For example, Balfour Beatty, which maintains a master insurance policy covering its entire military housing portfolio, was required by the insurer to implement a $25 million self-insured retention for losses funded at a pro rata portion of claims incurred by project. Under this plan, the insurer provides full insurance coverage only after the $25 million in claims are met and allocated by the fund. High insurance costs are unlikely to decline in fiscal years 2023 and 2024 as insurers seek to align premiums with property and casualty losses.

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