I’m a Real Estate Investor and an Insurance Agent. How Do I Cover My Properties?
Real Estate Investors want to maximize their cash flow and NOI. In order to do that, expenses need to be kept to a minimum. One of those expenses is insurance. Eliminating it completely typically isn’t an option. Investors want protection from disasters and potentially large losses. So we have to find a balance between paying through the nose and having good coverage. But how?
First, we need to establish how much risk we are willing to take on ourselves. We start with the amount of cash on hand that we are willing to use in the event that one or more properties are damaged. We need to analyze how close our properties are to each other. This is important in evaluating our risk from weather events. If the properties are in close proximity, they are more likely to be damaged in the same event. If they are spread out, this becomes less likely. Plan accordingly.
Next, it’s a good idea to compare the savings we could realize to the increased amount of the deductibles we choose. For example, if I increase my deductibles by an extra $10,000 which saves me $2,000 per year, that may be worth it to me. But if it only saves me $200 per year, it’s probably not worth it to me.
So, what about coverages? Which ones do I need to make sure to get and why?
The first coverage you want to make sure to get is the coverage for the property itself. Whether this is a single-family, tri-plex or 500 unit apartment complex, you want to make sure you get a few things right on this. First is the amount of coverage is important. If you want to have adequate claim payouts, without co-insurance penalties, you need to make sure to insure it to full replacement value. That’s basically the amount it would take to rebuild the structures and not what you are buying it for. If you fail to get this right, or at least very close, your claim payouts could be penalized. Not good. The second part you want to get right is that you have Replacement Cost Loss Settlement, not Actual Cash Value. The difference in claim payouts could be massive, depending on the age of the structures because ACV takes age into account and reduces payout accordingly. The third big thing to get right is your chosen peril coverage. If it’s a 1 – 4 family property, you want a DP3 with open peril coverage. If it’s more than this, (or commercial property) it will be covered on commercial paper, in which case you want to get Special Cause of Loss. These are the most broad form of coverage you can get. They don’t typically cost much more than a named peril style of coverage and put the burden of proof on the insurance company, not you.
The second coverage you want to make sure to get is Loss of Rent (1 – 4 family) or Business Income (commercial or multi-family). If you have damage that is being covered by the insurance policy, there’s a better than average chance that you’ll lose rental income for that property or unit. This could be a big hit to the bottom line and it can be insured. There’s no reason to go without it.
The third and final big ticket coverage item you want to make sure to obtain is liability coverage. This is typically pretty inexpensive, so get as much as you can. The last thing you want to happen is for something to happen on your property and for you to foot the bill for lawsuit defense or even a large judgement against you. It could mean the difference between keeping your property and having a new partner or even losing it. So, even if a lawsuit is frivolous, if it could even potentially involve your liability policy, the insurance company has a right and duty to defend you. Most good policies provide defense coverage outside of the policy limits.
The final important coverage is for building ordinance or building codes. It comes into play in two ways. First, if the damaged area has to be brought up to code and doing so costs more than repairing or replacing to the existing standard, this coverage comes into play. Second, if there’s enough damage, some local ordinances could require you to bring the whole structure up to code, potentially even demolishing and starting over. So it’s a good idea to consider what the local ordinances are in regards to this. The last thing anyone wants is to have a damaged building that can’t be permitted, no repairs made, basically stuck, or huge amounts of money out of your own pocket.
To recap:
- Correct Property Coverage
- Loss of Rent or Business Income Coverage
- Liability Coverage
- Building Ordinance / Building Code Coverage.
Everything else is going to be for very small, and highly unlikely things. A couple of examples would be equipment breakdown or service line coverage. They are going to be optional.
If you have the right sets of coverage with deductibles that are not too high for the amount of cash reserves you have on hand, your property will get put back, probably better than it was before, you won’t lose out on revenue and your business will continue on nearly unscathed.
If you want to talk more about it with an agent who is also an investor, I’d be glad to do that. Call me at 281-320-9292 or email me.
Happy Investing!