Just as you need to buy insurance for your automobile and the home you live in, you'll need to buy the proper insurance for each of your rental properties. Unfortunately, insurance laws are different in each state, but this primer will help you determine and find the coverage you need.
Basic Policies
The basic homeowners insurance policy covers four areas:
- The structure of the building
- Personal belongings
- Liability for damage to other people and their property
- Living expenses in case a disaster forces the owner to live elsewhere while the building is repaired
As a landlord, you are only interested in two parts: home structure
and liability. You shouldn't need coverage for your personal belongings or
living expenses because you aren't planning to live on the property.
House Structure
This section of an insurance policy explains how your building and the yard are covered in the event of fire, hail, lightning, hurricane and all other disasters enumerated in your policy.
Liability
The liability portion of the policy protects you against personal injury and property damage claims or lawsuits. Even though you won't be living there, you want to protect yourself in case one of your tenants destroys someone else's property.
For example, what happens if one of your tenants has a party, allows too many guests out on a deck, and the structure collapses? Are you liable? Are you liable even if you explained exactly how many people could safely stand on the deck and your tenant disregarded the warning?
Because insurance requirements, not to mention liability laws, differ from state to state, you will need to consult your local insurance agent about how much liability coverage you should carry.
Perils
Homeowners insurance policies protect their owners against a variety of disasters, called "perils." Most people buy insurance that covers the following hazards:
- Fire or lightning
- Windstorm or hail
- Explosion
- Riot or civil commotion
- Damage caused by aircraft
- Damage caused by vehicles
- Smoke
- Vandalism or malicious mischief
- Theft
- Volcanic eruption
- Falling objects
- Weight of ice, snow or sleet
- Accidental discharge or overflow of water from plumbing, heating, air conditioning, sprinkler system or household appliance
- Sudden accidental burning of a hot water heating system, air conditioning or sprinkler system
- Freezing of plumbing, heating, air conditioning, sprinkler system or household appliance
- Sudden accidental damage from artificially generated electrical current
Insurance agents in many states use a type of policy that protects your property from all disasters except the ones specifically mentioned in the policy. The perils that are not included are:
- Flood
- Earthquake
- War
- Nuclear Accident
- Landslide
- Mudslide
- Sinkhole
In most states, there is a specific type of insurance policy for those who own rental property. You want your policy to cover all of 16 basic perils named above and as many of the flood and earthquake hazards as possible. In addition, you will want to cover anything on the property that belongs to you, such as the appliances you provide.
Definitions You Need to Know
Every word in an insurance policy is important, but three terms are of particular interest to real estate investors: cash value, replacement cost and guaranteed replacement cost.
Cash Value
If your policy says "cash value," you will be paid the cash value of the damaged property at the time of the disaster minus any depreciation costs.
Replacement Cost
If your policy says "replacement cost," you will get your damaged property replaced. That means your building will be rebuilt if it is completely damaged. But the money you are paid has depreciation costs deducted.
Guaranteed Replacement Cost (also known as Extended Replacement Cost)
If your policy says "guaranteed replacement cost," you will be paid the cost to rebuild your building to its predisaster level, and depreciation isn't considered. This kind of policy, however, usually doesn't include bringing your property up to current building standards.
When purchasing this type of policy, you will need to consider what it will cost to rebuild your building. Often this amount has very little to do with what you paid for the property in the first place. Experts suggest that you discuss rebuilding costs with a local builder or a knowledgeable real estate broker.
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