You’ve decided on your first, third, or hundredth new investment property, and now the real work begins. Is the property turnkey ready for tenants? Does it need some cosmetic rehab, or maybe some more extensive work? Is it a ground-up construction project?
The answer to those questions will help you choose the most appropriate insurance policy for your property.
Before we dive into the details of each policy type, let’s review some general best practices for any investment property that will undergo some form of rehab.
Total Completed Value
Selecting an appropriate coverage amount for the property plus any improvements is an excellent first step. The cost of materials, labor, and inflation can increase these amounts, so what you may have insured a property for two years ago may not be the same calculation today.
Your best practice will be to insure the property for Total Completed Value. A simple rule of thumb for valuation for insurance is selling price minus land value.
Insurance agents have many tools at their disposal to help you select the appropriate coverage amount. They can utilize building cost data based on the scope of the project and the geographic area to determine an estimated cost to rebuild. If you are using a lender to leverage your project, you will also need to adhere to their insurance requirements for the loan. They will often require your insurance policy to, at minimum, have a builder’s risk endorsement. They will also require the property coverage amount to be at least up to the loan amount unless a full replacement cost estimate is provided proving the need for a lower coverage amount.
General Liability
Many investment property insurance policies also include general liability insurance. Make sure yours does. We recommend a $1 million per occurrence coverage amount here.
When conducting any level of rehab, it is best practice for the property to be vacant. The use of licensed contractors and labor that secure the premises before, during, and after their work, including raw materials, ladders, etc. will help mitigate any theft or vandalism claims along with injury liability claims, including trespassers. If maintenance on the property needs to be done while tenants are occupying the property, the same best practices above apply. Be mindful and aware of potentially harmful fumes or airborne materials. It goes without saying, but please don’t fumigate the property with tenants inside.
Builder’s Risk Endorsement
Cosmetic rehab of a property typically includes painting, updating fixtures, or remodeling a bathroom or kitchen. An insurance policy for this project often looks like a rental property insurance policy with the addition of a builder’s risk endorsement.
An endorsement in insurance changes the base policy by adding, removing, or modifying the language in the policy. Specifically, a builder’s risk endorsement could add coverage for fixtures and machinery, equipment used in the course of updating the property, and building materials and supplies used for construction. This endorsement will often expire if construction is abandoned, 60-90 days after construction has been completed, or once the property has become occupied. Please note this doesn’t cause the entire policy to end, just the builder’s risk endorsement.
Course of Construction
When performing more extensive work on an existing structure, such as adding additional square footage or moving load-bearing walls, a more robust policy may be needed. These policies are often referred to as course of construction policies and can include many optional bells and whistles.
The basic coverages are the same as a builder’s risk endorsement, but often with higher limits of coverage and broader perils covered. There can be additional coverages that are included or are optional, such as materials in transit or at a temporary location, backup of sewers and drains, ordinance and law coverage, and debris removal. Certain soft costs can also be added to the policy from project delays, including architect fees, interest on construction loans, license or permit fees, and more.
Ground-up Construction
An insurance policy for ground-up construction is essentially a course of construction policy as outlined above, but with added underwriting guidelines and considerations. Again, selecting the most appropriate coverage amount is the first step. Remember selling price minus land value or ask your insurance agent.
In ground-up policies, you will want to be more diligent in your selection of additional coverages, especially having the option for a change order endorsement. A change order endorsement can increase your coverage amount, often in increments of 10%, if the scope of the project exceeds your original valuation. This endorsement can provide peace of mind if costs go up or the project timeline gets extended.
All the coverages, endorsements and exclusions touched upon above can vary greatly between different insurance carriers and markets. As with any insurance policy you purchase, it is important to understand the coverages included and the exclusions of your policy. Having an in-depth conversation with an experienced insurance agent about the scope of your project and asking as many questions as needed is critical to selecting the most appropriate insurance policy for your next investment property.
Sam Brust leads business and product development for Ross Diversified Insurance Services. RDIS has been serving the investor community for more than 35 years with insurance products ranging from single rehab properties to large portfolios of 500+ rental properties nationwide.
Brust attended CSULB for business administration and accounting. He then went on to build call centers for various unsecured debt and credit verticals before starting at Ross Diversified Insurance Services.
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