I am continually amazed at how people purchase property insurance – particularly when they get a real deal on a property, way under market.
My theory is that if I get a great deal, even more reason to get great insurance and to preserve the built in asset and equity.
But, many people do not want to insure property for much more than for what they paid for it, particularly if they get a good deal. Seems backwards to me. Personally, my thought is to preserve the equity position with insurance.
Many investors’ approach, however, is to underinsure and risk a total loss. If there is severe damage to the structure, their plan is to simply bull-doze it and scrape the pad & sell it. But, there goes your equity!
My preference is to properly insure the property so that if there is a severe fire, we can put it back together again. Here is a scenario and the impact of underinsuring properties:
Client has purchased, for $127,000, a rental property. He is insuring it for $140,000 (somehow, the lender lets him).
He has a Kitchen & Roof Fire, and it will take $142,000 to do the repairs.
· $130,000 to replace the kitchen and damaged roof structure
· $12,000 increased cost of construction due to code changes.
Our Safeco insurance program would have insured this property for $202,000 (more accurately reflecting the replacement cost of the property), and it will pay the $142,000 to fix the property as we are fully insuring the building for the cost to replace it.
However, the client purchased a policy that more closely reflected the market value of $127,000: He insured it for $140,000. To begin with, this policy doesn’t have enough to pay the entire loss; it is short by $2,000 (not a terribly big deal). However, because he knowingly underinsured the property, the insurance company runs the numbers AND depreciates the loss by about 12% due to the underinsurance clause in the policy. They only pay $114,400. Now, it’s not a difference of $2,000 but rather a difference of nearly $30,000.
Which policy was a better deal?
And, what are you going to do: Would you really knock it down and walk away with basically nothing, or would you fix the home and preserve your equity? The options are expensive, either way, unless you are properly insured.
So, that’s why I prefer to properly insure property: to be able to replace it, and to preserve the equity. As you can see, it preserves far more than just equity positions. And, the cost to properly insure the property is not all that much more.
So, don’t slice & dice your protection; it just isn’t worth it!
Huggins Dreckman Insurance, Insuring Your Success!