An investor just blew $45,000. Want to know why?

[Timothy W.]

An investor who had a fire at their property had full insurance coverage on the loss, the policy was in force, had about $90,000.00 in damage, had a limit of insurance of 1.5 million dollars, and was a clear cut case of a covered loss that should have had a full payout less the 5k deductible. However, the investor blew $45,000.00 of the insurance payout by doing one thing wrong. Care to know what that is?

[Timothy W.]

Here's the error.

When you insure a large multi unit property, you often have a coinsurance agreement where you are required to give a value of the property that is 80-100% accurate in the REPLACEMENT value of the property. This can be a problem with investors who are used to buying property at deep discounts in order to increase their cashflow and insure the property for "how much they have into it." It doesn't matter how much money you have into a property when you have a coinsurance agreement in your policy. What matters is how much it would cost in real dollars to physically replace that property.

Let me give you a real world example. I have 2 buildings in Chicago, both 100 units, both the same size, both the same construction style and age and quality. One will have a market valued of 4.5 million based on it's location, the other will have a market value of 1.5 million. That doesn't matter if you have a coinsurance agreement. If you have a coinsurance agreement, what is going to matter is that each property is worth 3 million dollars in Replacement value (i.e., the actual cost to rebuild on a fresh lot new). This isn't a problem for the guy who insured his property for 4.5 million (he may be overinsured). This is a BIG problem for the guy who had his property insured for 1.5 million and has a coinsurance agreement.

In this case, this is exactly what this investor did and has a coinsurance agreement not of 80%, but of 100%. That means he needed to carry insurance of at least 100% of the building's replacement value or he would only be paid out the percentage of the claim that represent the percentage of the building's replacement cost he insured.

In this case, he was half insured.....so it's going to penalize him half his insurance payout. It sucks finding this out on the back end. If you're going to get this kind of insurance, get a real replacement valuation on it. Don't rely on the appraisal you got at closing or the tax assessor's value.