Update: I’ll leave a few notes in here for anyone else in a similar situation. Here’s what we learned
We didn’t end up following through with this deal for unrelated reasons, but it was located in an area that was evacuated the last 2 years in a row due to wildfires. The property was in a “very high” fire risk area according the agency that classifies land in CA. Due to this, the California Fair Plan was our only option for fire coverage (no other carriers would touch it, although some legacy properties are grandfathered in through other carriers), and then we would have had to buy a separate policy that provided other coverages for the house (like water damage, etc)/ business liability.
The Fair Plan piece came out to around $10K per year for a policy covering around 1M in property and 200k lost income. This was primarily driven by the fact that the property was >5 miles from the nearest fire station. They indicated that our rates would have been 50% lower if we would have been within that radius. The other insurance piece came out to around $2k/ year - way les
$12k/ year in insurance definitely didn’t help our underwriting, but it didnt “break” the deal for us either. We ended up pulling out instead bc renovation costs and timelines weren’t in sync with our yield target and desired amount of time investment. Another story for another day
Strategically, we thought about fire risk in 3 ways
1) Catastrophic scenario where the house actually burns down: it can take years to obtain permits and actually rebuild a home, plus demand in the area could suffer long-term if the entire area burned, so we agreed we should insure at an amount we could walk away and feel good about it. So we insured more than the value of the home - closer to what we would expect the home to sell at if priced at cap rate in an exit to another investor. We also agreed to increase the coverage if the property was more successful to account for the larger premium we could eventually sell the property for. Ironically, this seemed like the least scary scenario since we were insuring against it
2) Scenario where some of the surrounding areas burn, but not our property. This would have been a terrible setback since this property was located just outside of a national park. If fire caused market demand to fall for a prolonged period we would be stuck with an untouched by fire, yet rapidly depreciating asset due to demand falling off a cliff. From my understanding insurance doesn’t cover this, so we essentially had to factor it in to our overall investment decision and weigh the risk against our projected returns
3) Routine scenario where we have to cancel reservations during evacuation times. This one is somewhat likely to occur, and luckily the revenue estimates we were using from Airdna/ Pricelabs had this baked in somewhat since evacuations had happened the last 2 years in a row. So we basically underwrote the deal assuming the property would have an additional 5 or so weeks of vacancy per year to account for this.
4) Exit risk: we hope to sell our STRs at cap rate to other investors in the future, but realize not all buyers will want to take on wildfire risk themselves for reasons mentioned above. So we saw this property as somewhat "less liquid" than a "normal" STR without these same risks. I doubt this would be a huge issue today, but as wildfires become more and more prevalent I could see this becoming more of an issue over time. Not a showstopper for us, but definitely something we pondered
Anywho, like I said- posting this as I’m sure someone will search for this in the future with similar questions. Feel free to PM me if you’d like any additional info - happy to help in any way I can!
