HOW MUCH IS TOO MUCH WHEN INSURING RESIDENTIAL PROPERTY?

Question

Hello fellow investors, I need some advice. This is for a property someone else will be managing for me. I am getting ready to close on a four Plex in the next month and I'm having a hard time deciding on how much insurance is needed. C class residential area. I have heard of another investor that will only ensure it for the ARV price.

Thanks

JD Martin · Answer

Whatever you do on the property, make sure your liability coverage is sound. When you are running a commercial venture - and that's virtually anything that you sell to make money, including renting out property - your biggest risk, financially speaking, is from liability you may incur to others. Someone falls and breaks their neck because you didn't fix the handrail. Someone dies in a fire because you didn't provide smoke detectors. ETC. The coverage of the building is relatively small compared to the amount of coverage allotted to liability.

Ask your insurer to add or take things away and you'll see how the numbers change. The basic liability of my policy is a good part of the policy, but adding an extra million to coverage added only a few dollars to the policy. You can do that with most facets of the insurance - deductibles, ACV vs RCV, etc.

Michael Norris · Answer

Insurance by it's simplest definition is a "transfer of risk".

For a relatively small amount of money (your premium) the insurance company is agreeing to take on a specified amount of risk (policy coverage) that is spelled out ad nauseum in your policy.

As the property owner YOU have to decide the level of risk you are willing to accept.

Generally speaking... less coverage costs less money but not always.

Some states are just flat out really expensive to get insurance no matter what kind of coverage you get so I can't help you there.

As @Jason Bott said above you can have policies from different providers that all show the dwelling insured for $250,000 but how the company actually settles on payment (ACV or RCV) and what types of losses they will pay out for can be dramatically different.

The time spent talking with an investor friendly agent and asking a lot of "what if" type questions is invaluable.

There is no blanket right or wrong to this - YOU have to decide how much risk you're willing to accept.

I have many investor clients who insure their properties for well under the RCV and carry high deductibles on top of that. They are financially sound, experienced, and have a local team of contractors to do work for them.

I would never recommend insuring a property for only it's market value if you are a newer investor and/or... finance the purchase of the property, could not afford to come out of pocket to pay to completely rebuild a useable property should a large loss occur.

Yes the chances of a major loss occurring are low - but if it does happen... you could be wiped out.

Example: You buy a house for $50,000 with an estimated reconstruction cost of $150,000.

If it catches on fire - could you afford to pay the difference from your $50,000 policy coverage versus the $150,000 (ish) to actually rebuild it?

Maybe you say you'll just take the money and buy a house down the street. Ok maybe.

You will still have to pay to demo the damaged property and that can run from $15k to $40k or more depending on where you live so you may not have much left of your initial investment to buy that next property.

And if you financed it - the bank is going to take the majority of the insurance settlement to settle the loan and you will own free and clear a fire damaged house that the city will eventually start making demands for you to repair or demolish.

This is why the majority of lenders require you to carry full replacement cost coverage. The edgier lenders will require you to insure at least to cover the amount borrowed because... their name will be on the insurance settlement check along with yours and they will be happy to cash that check and close your loan account leaving you to figure out what to do with a heavily damaged home.

Scare tactics? - I guess you could call it that I look at it as being aware of the potential worse case scenarios and deciding how much risk you can take on should one of those things happen.

Craig Curelop · Answer

@Diana Dorantes - It really depends on what your comfort level with risk is.

Insurance companies make money on the fear of their clients. They make money on the majority of the policies they provide. The odds are that you will pay your insurance providers your monthly premium and they will pay out less in claims. Otherwise, they would not be in business. So don't fall for the scare tactics or anything that anyone tells you.

If you have done your homework and the property is sound, there should be nothing materially wrong such that a reasonable insurance policy would not cover.

If you continue to do your homework and screen your tenants properly, you should have a low risk of them destroying the property that an insurance policy would not cover.

Peter Jahn · Answer

This has been the best thread I've read in awhile! Really stirred opinion and professional answers! Diana, if you'd like to talk through how ACV vs RCV affects your specific scenarios, please feel free to DM me.

John Mocker · Answer

Diana,

Another consideration in your decision on what level of coverage to get is How the policy will respond to a partial loss.  If the policy is based on Replacement cost (RC) and you have insured it to the amount you are required to, the policy will pay the full amount on a partial loss.   Actual Cash Value (ACV) is the other major option for valuation under a policy.  It means the RC minus depreciation.  In a partial loss, ACV policies will pay the cost to repair minus depreciation.  It could mean out of pocket expense in the thousands or tens of thousands.  Your ability to pay the difference in a partial loss should also be considered

Jason Bott · Answer

Diana, don't focus on how much you are insuring it for.   There are many different policies out there and they are not structured the same.

What you want to focus on is what claim payout the policy will pay you if you have a loss.

You could have 5 policies insure you for $250,000, and each will pay out a different amount on the exact same claim.

Peter M. · Answer

Agree with @Dennis M. 100%. Don't focus on the overall price as much as what coverage you are getting. Optional things like slab leak coverage, earthquake, tenant damages, vacancy allowances and other things not normally covered if you feel it is worth it. For example it only took one slab leak for me to realize it was worth the extra $10-20 premium. Paid for itself 6 months later when one of my rentals got a new slab leak. Only downside was the one that taught me the lesson was my own residence and the kicker was a RE agent told me I should get it and I blew her advice off.

Diana Dorantes · Answer

I really appreciate your recommendations and thoughts!  I think I’m better able to choose the right amount of insurance for my properties.  I also plan to choose the coverage I feel is enough and look into the optional add-on’s depending on the area.   Thanks again

HOW MUCH IS TOO MUCH WHEN INSURING RESIDENTIAL PROPERTY?

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