How do you establish the insurable value of a property that you are purchasing?
In most of California, the market value of rental properties is still is more than the cost to rebuild, so we generally don’t have issues of insurance valuation on income properties. But in most other communities around the country, questions about valuation is extremely relevant to Landlord insurance policies as most people are struggling with understanding insurance valuation that seems excessive compared to the market value of the property.
It seems counter intuitive to insure a home for $279,000 when your offer of $119,000 has just been accepted and approved by the bank. Why pay insurance on a value that is more than twice the purchase price of the property? In my case, I was lucky; my insurance valuation was just 50% more than what I paid for the property. But, that was in a less volatile area in the U.S. In the areas that experienced severe market price reductions or that have lots of inventory, they are still feeling the pain of what appears to be excessive insurance values and the premiums that go with it.
Part of the problem with insurance and the insurable replacement value is that the amount of money spent on insurance repairs is more akin to remodeling costs – and then some. But, when you purchase a rental property, you are generally provided comparatives for building costs that mirror new tract construction (and all of the savings that come with a volume construction effort) rather than individual structure building costs.
It is much, much more costly to handle a severe fire loss on a single property than it is to build a tract home. With the costs of
- debris removal, following a fire;
- board up, fencing and other property safety expenses; and
- the charges from insurance specialty contractors who will do the initial clean up; and
- then the contractors who actually do the repairs:
You'll find that the costs to rebuild a property are staggering and bear absolutely no relation to the large builder’s cost formula.
This is true in all areas of the country, not just the metro areas in the blue states. We belong to a marketing group of savvy agents from all over the country, and they are all dealing with the same issue: tons of under insured properties – and, that's a dangerous game.
We even see many insurance companies and agents purposefully undervaluing the insurance on rental properties just so as to get your business. In effect, they are betting you'll not have a total loss, so in order to obtain the business from you, they undervalue the properties and thus you seeming have a great deal! But, too good to be true generally is, so read your policies if your properties are insured at very low values; you are likely not receiving the coverage that you think you are.
There are few solutions to the insurance valuation dilemma.
1. Accept your insurance company’s legitimate valuation systems to establish an insurable value of the property, or
2. Willingly set yourself up to take a cash settlement in the event of a total loss by willfully underinsuring the property (at least you can pay off the bank and scrape the lot and sell the land).
3. Under insuring may make tactical financial sense if you are ok with a cash settlement and not the full value of the property. Some people will do this, particularly when they have a one or two year exit strategy. And, if you do this, don’t sue the bank or the agent; it was your decision.
Our specific program (landlordinsuranceusa.com) is not geared to that method of property under-valuation; it is set up with the intention to provide funds to replace the property up to the policy limits plus 25% (the extended replacement cost endorsement) so that you’ll have adequate insurance to put your investment asset all back together when it’s broken.
And, from my perspective as a property investor, it makes total sense to properly insure these properties, as you are risking your future equity “going up in smoke” if you under insure your income and investment assets.