What Kind of Insurance Do You Need as a Real Estate Investor?

by | BiggerPockets.com

Insuring an investment property is something every investor will want to do.

In truth, it’s probably an expense an investor would like to skip, but seeing your hard work and money go up in smoke is a nightmare that can ruin years of work. Here’s how to avoid that, or at least insure against it.

Actual Cash Value Policy vs. Replacement Cost Policy

How do you choose the right insurance?

For homes that will need some fixing up, the choice may be partially made for you, because you may be limited to an actual cash value (ACV) policy. That means the insurance company will give you only enough insurance to cover what you paid for the property, minus the value of the land it sits on. This often occurs when the house is older and the plumbing, electrical, and roof have not been fully updated.

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. But 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 (because of depreciation) or do some of the work yourself.

An important note about ACV policies is this: about one-half of them don’t cover water damage from frozen or broken pipes. In some cases, you just can’t get it because of age or something else. But at least it’s good to know that up front or get it endorsed to the policy if you can.

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Related: 5 Types of Insurance You May Need in Your Lifetime

On the other hand, a replacement cost policy is the preferred option if you can get it. The coverage is better, and it will pay for the full cost of a covered loss (minus your deductible) or even to fully rebuild the house, if necessary. To qualify, the property must be in good condition, with the roof and paint in good shape. I can’t tell you how many times over my years in insurance I’ve come across houses that couldn’t get a good policy because of the condition of the roof or siding. Other problem issues include a lack of gutters, no handrail on the stairs, 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 will usually cancel the policy if they see that.

When looking at a replacement cost policy, make sure the dwelling coverage (Coverage A) involves enough of a payout to rebuild, based on what contractors are charging in your area. In some cases, this number may not be even close to what you paid for the property. It could be much more or much less, and a lot of people are surprised by that. It does not matter what you paid; it matters what a contractor will charge you to rebuild that same home in the same construction style on the same lot.

Coinsurance Penalty

With most policies, if you are more than 20% under market costs, you will be subject to a coinsurance penalty. This means that if the home would cost $200,000 to rebuild, and you are insured for less than 160,000 (80% of value), any claim you have will be paid out at the same ratio. For easy math, if the value is $200,000, and you insure for $100,000, you are at 50%. If you have a toilet overflow that causes $8,000 in damage, the insurance company would pay only 50% of the cost—$4,000, minus the deductible. This is because you were only insured at 50% value on the home. Watch for this, and make sure your house is insured to full replacement value. (Note that with an ACV policy, you can usually get one that will pay 100% on partial losses, even though the home coverage is not at replacement value.)

Next, make sure your policy includes outbuildings (garage, shop, etc.), if you have any. Also look for “loss of rents coverage.” If your renters have to move out after a fire or other covered damage to the home, this will pay you the rent you would have collected from them during that time.

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Related: LPMI: What is Lender Paid Mortgage Insurance and Is it Right for You?

Liability Coverage

Lastly, make sure you have liability coverage on the home. Common limits are $300,000, $500,000 and $1,000,000. It doesn’t cost much to get the higher coverages here, so it’s almost always worth it. If someone gets hurt and sues you, this coverage is a lifesaver. I recommend requiring your renters to carry their own renter’s insurance as well. It’s very inexpensive for them in most cases, and if they are found liable or negligent in an injury, it’s good to have a policy for that claim to go against rather than having your insurance be the only option. And while we are talking about tenants, don’t let them have dangerous dogs or other pets. If you’re a serious investor, you don’t want a dog bite claim on your record. Insurance companies hate those.

I hope that helps you out on your journey toward real estate success. And keep in mind, having a good agent who can look things over for you is always a plus, but being armed with at least basic knowledge is extremely valuable for every real estate investor.

Any questions about insurance for investors?

Leave your thoughts below!

About Author

Brandon Turner

Brandon Turner (G+ | Twitter) spends a lot of time on BiggerPockets.com. Like... seriously... a lot. Oh, and he is also an active real estate investor, entrepreneur, traveler, third-person speaker, husband, and author of "The Book on Investing in Real Estate with No (and Low) Money Down", and "The Book on Rental Property Investing" which you should probably read if you want to do more deals.

6 Comments

  1. Dan Redmond

    Having had a fire 8 months ago, given the real world that came with, I have one very important addition. Before ever signing on the dotted line, ask to speak with those who previously had a claim with the same policy you are being presented.
    We had paid extra to have more zeros added to the numbers mentioned above but if working out a claim goes bad in terms of just general hassle, it does not matter how many zeros are on the paperwork. Getting rent reimbursement still an ongoing problem. While we had total replacement and code upgrade, the number arrived at was for ‘as was’.
    We are now selling out at a much lower number than prior market value because we needed an all cash buyer. We will land on our feet because we were long time holders in SF, but it still hurts. Our fault, we did not do enough due diligence on how well is this going to work if something actually does go wrong. It is more than the zeros.

    • Nicole Dunbar

      @Dan – Do you mind sharing the insurance company name? PM is fine if you prefer…

      ALL – curious…has anyone worked with National General Home Insurance? They seem to be newer in my area, have very competitive rates, and are one of a few companies that cover Residential MF.

  2. Within the lease, I give renters 30 days to produce a policy cover page that names me as the other named insured….or they get a three day quit/perform. Once that happens, the insurance company is compelled to let you know if they cancel, stop paying or even try to take you off. Landlord policies only cover the structure(s)! Get your coverage with an umbrella…even if you only have one property. Even if a tenant doesn’t own a dog, and they have a visitor with a dog that goes and bites someone, you will be sued as an ‘other named defendant’. Landlords can be sued by anyone for any liability that a tenant is responsible for….get an umbrella!

  3. Amy A.

    Brandon, how did your claim for your fire go? From what I’ve heard from other investors, my first call would be to a lawyer if I had a large loss. It’s too bad insurers don’t use plain language to explain coverage. Your post here explains it better than most insurance agents can. They are just salespeople.

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