Whether you own one tiny rental or a portfolio of 200 locations, here’s how insurance does and doesn’t protect your investment properties:
Property, Liability, & Business Income Coverage
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Here’s an Overview:
As a property owner, there are three primary things your insurance policy should protect:
Property (Dwelling Coverage)
The most obvious coverage is for the structure itself. If something bad happens to your investment property its value is diminished. That could be a total loss like a fire or tornado leveling the structure. It could also be a partial loss like a burst pipe causing water damage to your wood floors.
This is listed as DWELLING coverage on your insurance policy. It’s the most important property coverage.
There is very limited PERSONAL PROPERTY coverage on a Dwelling owner’s policy. This is because you don’t usually have belongings in the house. The personal property of your renter is NOT covered under your insurance policy. This is one reason for renters to have their own RENTER’S INSURANCE POLICY.
This is coverage for bad things that happen to other people because of you or your property. Common examples are a person falling down the stairs, tripping on your sidewalk, or being injured by faulty construction.
The renters living in your property are the most likely to experience these things. That’s why most rental contracts have “Hold Harmless” clauses. This is something you should talk to a lawyer about when creating your rental contract.
The second group to potentially experience injuries on your property are the friends and family of your renters. This is the most important reason to REQUIRE TENANTS TO HAVE A RENTER’S POLICY. Liability on a renter’s policy would be first to respond and make you less likely to experience a liability claim.
The third major coverage protects the income that you receive from a property. If there is damage that requires a renter to move out for a period of time, you likely won’t receive rent payments. Business Income coverage replaces that lost income.
Appraised Value VS Replacement Cost
The DWELLING COVERAGE is the maximum limit an insurance company would pay out for damage to your property. Many investors think this has something to do will how much your property is worth. That is incorrect. The Dwelling coverage is figured based on REPLACEMENT COST. Replacement Cost is the estimated amount it would actually cost to rebuild the structure. The figure includes the cost of contractors, wood, drywall, roofing, etc.
Sometimes Market Value and Replacement Cost are close. Other times they are significantly different. For example, let’s say you buy a 2000 square foot house for $100,000. The insurance company will likely want to insure it for around $250,000 ($125/square foot). You may feel like the insurance company is insuring it for way too much but the reality is you bought the house for much less than it would cost to rebuild. Market Value & Replacement Cost are not the same thing.
You might say, “I don’t care. I bought the house for $100,000, let’s insure it for $100,000.” You wouldn’t be the first person to think that. Maybe you don’t even care if $100,000 is all you’d get in a claim. But actually, you wouldn’t even get that. Insurance companies have a rule to combat under insuring a house and it’s called the COINSURANCE CLAUSE.
Insurance companies have a rule to combat under insuring a house: the dreaded COINSURANCE CLAUSE. Click To Tweet
In a claim, EVEN A SMALL ONE, the company will assess whether you’re dwelling coverage properly insures the house. If it doesn’t, a formula is used that diminishes the claim payout in direct relation to how much you underinsured.
In the above example, if the house totally burned down you’d get about $40,000.
Perils Insured Against
Insurance coverage is based on the bad thing that happened (occurrence). Different policies list different events that are (or aren’t covered). Here’s the 3 primary options:
o BASIC (DP1) – Covers 11 “Named Perils” including lighting, fire, smoke, wind, hail, and more.
o BROAD (DP2) – Covers 16 “Named Perils” including everything from Basic plus burst pipes, weight of ice and snow, and more
o SPECIAL (DP3) – The best kind. Shifts from what is covered to what ISN’T covered. If a bad thing that happens isn’t specifically excluded it’s covered.
Common Insurance Company Questions
When you call an agent for a quote on your new investment property they’ll likely what to know a lot of information.
Here are some highlights:
o How old is the roof?
o How old is the furnace?
o Do you rent to undergraduate students?
o Do you require renters to sign an annual contract?
o Do you require renters to carry renter’s insurance?
o Are there circuit breakers in the home?
o Is the property going to be vacant or under renovation?
Common Inspection Concerns
Most insurance companies send an inspector to the property AFTER the policy has been put in place. For larger properties, they may want to inspect before even offering a quote.
Here are some common issues they would likely want you to fix:
o No Fire Extinguishers – Smoke Alarms – Sprinklers
o No Railings on staircases
o Uneven walking surfaces
One thing that takes many investors by surprise is the limited billing options that can come with commercial insurance policies. Many companies expect full annual payment up front. There are premium finance companies that will help you spread the payment out but expect to pay a 25% down payment and about 6-10% above the cost of the policy itself.
Investing in properties is a fulfilling and lucrative way to multiple your money. Protecting those investments is one of the most important parts of what you do.
DON’T GO IT ALONE.
Find a reputable independent insurance agent. Ask them to coffee and get to know them. Your insurance agent is no different than your lawyer or financial advisor. They are the key to one element of the investment work you do.
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