Replacement cost value much higher than what I bought the property for?

Question

I am looking for replacement cost value DP3 insurance policies on my first rental property. I paid 71,500$ for the property, and it has brand new roof, plumbing, electrical, and floors.

I am being quoted for 171,000$ in dwelling insurance on DP3 policies. My question is

1) Am I over-insuring? Why are they insuring me at 171,000$ to rebuild the property when I can buy a new one for $71,500?

What am I missing here? Would it simply be enough to insure it at what I paid for it, because I don't see how the cost to rebuild can be higher than the cost of buying a new property?

Account Closed · Answer

@Ed O. Nope, I do not work for State Farm. Remember, leveraging your buying power will do great things in all aspects of real estate investing. We work with State Farm because they are incredibly competitive under our umbrella policy. When we go to sell these units to investors, they just keep our policy in place.

The same could be said for appliances, or lumber, or roofs. We leverage the 35 homes we build a month to ensure we get the best pricing possible. We keep each home consistent. Hope this helps...

Arlan Potter · Answer

actually it was several years ago, we were a little under insured.

It was a cheap house.  Insured for $25000.  Insurance paid $25000 less demo cost. We spent a little more to rehab. Then some more to make ready for sale. We then Sold the house. We have a commercial property that covers all properties with liability.

Ed O. · Answer

I'm not a fan of ACV policies. Insurance agents love them and will speak about how great they are.

I have no idea whatsoever how Account Closed is getting polices written at state farm with those coverages for the price. I have to ask, in the interest of fair disclosure - are you or your mother an agent? I got utterly clobbered by state farm, for no reason - rates lept up 30-50% -due to "market adjustment." Needless to say, I'm not a fan of those donkeys. I no longer work with them.

Bottom line, the insurance companies love it when a person overinsures. The more you insure for, the more they win. They know the odds and have the actuaries behind them. Just like how the casino will let you bet 10,000 on a spin of the roulette wheel - they know they will win over time.

Many agents balk at selling acv policies, or make up their own rules, in an effort to force you to overinsure. You just need to find the right one that will give you what you're after. Personally, if I have total loss on a rental, I'd rather be out of it, than forced to build a new house from the ground up.

There's a lot of people in Joplin that aren't happy with their replacement policies after the tornadoes wiped out their homes.

Make some more calls - call an agent or two on the other side of your state, who may see you as bonus business, not a local customer to try and steer into a full replacement policy, unless, you really want to build a new home right where your rental is on the very outside chance there's a total loss.

Good luck.

Account Closed · Answer

Kenton -Great question! The best thing to do is insure what that replacement cost is. Although you may be able to buy a distressed home today for less than it's replacement value, it is always ideal to insure for replacement cost. What if the place burns down 2 years from now and there are no more a distressed investment properties to buy? If you can't rebuild it for 71,500 then you're in trouble. We have bought/sold over 1500 homes and we insure them through Statefarm under a 100% replacement coverage, 1 million liability. That cost for us is $400 (on a home that's worth today $135,000 but to rebuild would be $185,000). Hope this help!

Thanks,

John

Kirk R. · Answer

Kenton C. I have USAA.  They have some crazy replacement values for the midwest.  They were like $215,000.  I got a quote from State Farm, their replacement value was $115,000.  My place is probably worth around $80,000.  If they gave me the $115,000 I would pay off the note and own a lot that isn't worth much - sure it doesn't work this way.

Best way to handle is just to get quotes from different insurance companies.  One landlord told me he had a policy for like $300.  I have been looking for $300 but have not found it yet.

Ed O. · Answer

@John Gutman

Thanks for explaining things further for me. That's an amazing rate, especially for State Farm. I had a couple of awful experiences with them in the past, in part I suspect, to the agent trying drive up prices, premiums and ultimately commissions for himself.

Kirk R. · Answer

I think it ends up being a negotiation with the insurance adjuster/company like other claims.

Kenton C. · Answer

So what would be a better value to insure at? I want to make sure that if there is a total loss, I am able to garner what I put into the property (71,500$), even if I do not rebuild (which under the RCV policy, If I do not rebuild, they will pay out ACV).

I insure the property for 171,000$ and there is a total loss 20 years down the line, and lets say the property is 50% depreciated, I would still be written out a check for 85,500 (minus my deductible), meaning that I would still get more than what I put into the property. Therefore, I think the 171,000 is a pretty safe amount to insure. If there were a total loss on Day 1 of the property, I would essentially be cut out a check for 171,000 (minus my deductible), even if I did not plan to rebuild, because there would be no depreciation. Am i right? What are your thoughts BP?

Ivan Oberon · Answer

Conventional insurance companies use their co-insurance requirements and high replacement cost values as a way to garner more premiums.  They also usually structure each location on an individual policy making the process not only more cumbersome but also making you subject to multiple deductibles if one occurrence were to damage multiple properties.  This is why a master policy schedule is better.  You also want to be sure not to insure your rentals on a "personal lines" policy as you could potentially run into issues since anything you derive income from is considered a "business exposure" and they also carry a total pollution exclusion.. Which means if one of your tenants gets sick or dies from carbon monoxide inhalation from a heating or cooling source, there is no coverage.

I would suggest working with a company that allows you to be free of co-insurance requirements so you can insure at a value you feel comfortable with.  As investors, we can also rebuild for much cheaper than the insurance company's Marshall  Swift calculators, or whatever they use to calculate their replacement cost figures.  So if you know you could rebuild for $90/sq ft, why would you insure at $150/sq ft?  You wouldn't, unless the insurance company you are working with makes you because of their insurance to value requirements.

Hope that helps.

Elizabeth Colegrove · Answer

As you can see everyone has their own opinion. :) Personally we insure for the value to replace. We were able to buy a ton of houses for less than build value due to the economy. Whatever you do make sure you are covered in the case something happens.

Replacement cost value much higher than what I bought the property for?

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