When it comes to insuring your investment properties, it’s critical that you have adequate coverage. This may be an expense you’d like to skip, but seeing your hard work and money go up in smoke—literally—is a nightmare that can ruin years of work.
Inadequate property or liability coverage may be just as damaging to your business as no coverage at all. Working with an agent that understands the unique needs of real estate investors and rental properties can go a long way in making you feel comfortable with your coverage.
What type of insurance do you need?
A traditional homeowners insurance policy is not appropriate for an investment property. Homeowners policies often exclude business ventures and come with much lower limits of liability.
For investment properties, you should have dwelling coverage and premises liability.
- A dwelling policy covers direct physical property damage.
- Premises liability can protect you in case of accidental injuries on your property.
We recommend a commercial property policy and a commercial general liability policy. Personal dwelling policies can contain exclusions or limited coverage that can be harmful to you as an investor.
How do you choose the right insurance policy?
Basic vs. special form coverage
The two most common levels of coverage are basic and special. These options determine what causes of loss are covered on your property policy.
- Basic coverage is a “named peril” policy, which means that in order for a loss to be covered, its cause must be named in the policy.
- Special form coverage means that unless a cause of loss is listed as an exclusion on the policy, it is covered.
When choosing your coverage form, consider your appetite for risk, your property’s occupancy status, where your properties are located, and any insurance lending requirements that may exist. For instance, basic coverage does not include water damage, which is often caused by burst pipes in cold climates. It also does not include coverage for theft, which can be more common in vacant properties.
Be sure you carefully review your policy to be familiar with and comfortable with the covered causes of loss and exclusions.
Actual cash value vs. replacement cost
These two options determine how your claims payout is settled in the event of a loss. The method available to you depends on the insured value per square foot, and every carrier has different thresholds at which each is available.
Actual cash value
In exchange for allowing you to insure your property to a lower insured value per square foot, which can save on your insurance costs, actual cash value (ACV) factors in depreciation that is not recoverable when calculating your settlement.
The downside for those insured with an ACV policy is that if the structure sustains major damage, there likely won’t be enough money paid out to rebuild. In a worst-case scenario, you may have only enough money to pay off the loan and be left with a vacant lot or a damaged building.
Regardless, an ACV policy is still better than nothing and will often be sufficient for small losses, especially if you are prepared to pay a bit more than the deductible or do some of the work yourself. Many investors who regularly do renovations and therefore don’t pay retail for supplies and labor find that the ACV settlement can be sufficient.
A replacement cost policy is the preferred option for investors who want to minimize financial risk and is often required by the lender, if you have one. With this type of policy, you will first receive the actual cash value settlement (minus your deductible) based on the adjuster’s report. Then once you complete the repairs or rebuild, you submit receipts for costs above and beyond your initial payout to recover the depreciation levied against you, up to your insured value.
For most insurers, the property must be in good condition, with the roof, paint, structure and premises in good shape and well-maintained. Other problem issues may include a lack of gutters, uneven pavement, and debris left in the yard. Don’t let your renters leave an old appliance or broken-down vehicle in the yard. An insurance inspector can cancel the policy if they see that.
Loss of rents (or business income coverage)
Commercial property policies for investors can include loss of rents coverage. This provides reimbursement for your loss of rental income if your tenants are forced out of your property due to a covered loss.
Many carriers allow you to choose the level of loss of rents coverage, usually three, six, or twelve months that the property is uninhabitable. Either way, this is protection all tenant-occupied property owners should have.
Other structures and business personal property coverages
Don’t forget to protect against loss of detached structures, such as garages, sheds, and outbuildings. If they are not specifically listed on the policy, a loss in the detached structure may not be covered. If you partially or fully furnish your rental units, be sure to include business personal property for your owned assets. Policies designed for landlords do not include coverage for the tenant’s personal possessions—they will need their own renters insurance policy for that.
What is co-insurance?
Co-insurance is a penalty levied on you during a loss settlement for underinsuring your property. A typical co-insurance amount listed on your policy is 80%, 90%, or 100% (the higher percentages are more detrimental to you). You are agreeing to insure the property to the defined percentage of the replacement cost of the property at the time of loss as determined by the adjuster.
To understand co-insurance, it’s simplest to look at an example. At the time of a loss, the adjuster comes out and determines it would cost $250,000 to rebuild the home to like condition. If you have an 80% co-insurance clause, then you must be insured to at least $200,000 to avoid a co-insurance penalty. If the home is insured for $100,000, you are underinsured by 50%.
Here’s an example. If you have a kitchen fire that causes $40,000 in damage, the insurance company would deduct 50% of this as the starting point for your payout—or $20,000. Then they would factor in depreciation for your initial ACV payout. For this example, let’s say 40% depreciation ($8,000), leaving $12,000. Then subtract your deductible. If you have a $3,000 deductible, the highest your initial payout may be is $9,000 on a $40,000 loss. If you have replacement cost coverage, you may be able to recover your depreciation, but you’ll never get a higher payout than $17,000 ($20,000 minus $3,000).
All this is to say, avoid co-insurance at all costs.It is worth the small extra cost of your insurance to have it removed to avoid the financial harm this penalty may cause.
What property deductible should I carry?
Simply stated, the higher your property deductible, the lower your premium. When choosing this deductible, consider the lowest claim you would have to turn in and do as much as double that amount as a starting point. Keep in mind that your claims history can affect your future insurance costs.
Deductible negotiations can be beneficial to save on your property costs, but liability deductibles are set by the carrier and it will not benefit you to attempt to negotiate in return for a higher cost.
What are additional endorsements?
Some of the exclusions listed on your property policy can be “bought back” through endorsements.
Some of these include:
- Earth movement, like earthquake shock or sinkholes
- Flood damage
- Terrorism and political violence
- Equipment breakdown.
Ask your agent about exclusions that concern you to see if you can add additional coverage.
Imagine how expensive and damaging a lawsuit can be. Medical payments, lawyers’ costs, lawsuit settlements—that’s why liability coverage is so important. There is no one answer to the right amount of liability protection to carry, you should discuss your options with your agent and determine what makes you most comfortable. Most commercial policies start at $1,000,000 per occurrence with dedicated limits per property and higher limits may also be available upon request.
Be sure your liability policy includes defense costs outside of these limits. Umbrella policies are often misunderstood. This type of policy provides additional liability limits if you don’t feel your underlying liability policy limit is enough. Many investors feel $1 million per location is sufficient but choose an umbrella when their portfolio grows. This is a personal decision for each investor that should be discussed with your agent.
Having a good real estate team—including a Realtor, lawyer, accountant, and insurance agent with experience working with investors who are all communicating with one another—to review potential policies is always a plus. But every investor should be armed with basic insurance information.