Choosing the Right Coverage
How It Can Make or Break Your Fix-and-Flip Investment by Jen Sitko Choosing the right real estate insurance to protect your investment projects can seem like a superfluous and unnecessary cost. After all, you want to sell the project as quickly as possible, so why opt for additional coverage? As a lender, Fund That Flip operates daily in the world of risk management, so we see firsthand where cutting corners for a lower cost leads to more trouble than it is worth. We’ll explore some of the supposedly “cost-saving” insurance missteps that could lead to disaster for your fix-and-flip project—and, more importantly, how you can leverage insurance to help minimize your risk and maximize the benefit to your business. Your Time is Money One of the most common mistakes when selecting an insurance policy is not carrying enough coverage on the property. As a real estate lender, we often see policies only written with enough coverage to protect the total monetary investment into a project (purchase cost plus your renovation budget). However, that calculation does not account for your time and labor, which, of course, are often some of the biggest costs for your business. While a total loss could be covered in this case, you will be left with nothing to show for the time you spent executing the project. …And Don’t Forget Replacement Costs Another oversight that real estate rehabbers often commit is failing to consider their estimated replacement costs. Insurance companies will evaluate based on that replacement cost, meaning it will be assessed on the cost if you were to knock down, excavate, and rebuild. If you choose to under-insure a property, you could potentially face coinsurance penalties and be shorted or denied claims if you fall below the standard 80% coinsurance clause. While not all coinsurance is 80/20, this is the most common, and the penalty will apply for any under-insured property, regardless of the ratio. Let’s take a closer look at an example: Your newest investment, a fix-and-flip, is evaluated at a $1,000,000 replacement cost by your insurance company, but to save on the premium, you only insure it for your anticipated sale price of $650,000. In this case, the home is under the 80% coinsurance clause ($800,000) and therefore, puts any claims you would make at risk for penalty and short payment. When evaluating real estate insurance, be sure to consider your time, labor, and most importantly, your replacement costs when calculating your coverage. Accidents Can Happen Another common misstep when choosing insurance is failing to specify on the documentation that there will be renovations made to the property. As a real estate investor, you know that unintentional incidents can occur at any job site, even to the most meticulous and careful. That is why it is a good idea to explicitly document that you will be renovating the property when choosing insurance. A vacant homeowner’s policy will protect the property as it currently sits; however, it will not cover the renovations being made or claims or losses caused by the renovations themselves. Take care that any policy you take out includes a builder’s risk endorsement or language stating that the building improvements are covered. When in Doubt, Choose the Special Form Now we’re really getting into esoteric knowledge. You may be surprised to learn that the actual form on which your policy is written matters. Special Form should always be your top choice so long as it is available. It is the broadest type of policy and coverage that you can secure, meaning that you basically are insured against any cause of loss that isn’t excluded on your form. If your agent says that Special Form is not available for the property in question, consider shopping your options. Not all agents may have knowledge or access to quoting you on a Special Form. Here’s an easy way to differentiate between the two: Special Form – if the policy does not specifically exclude a “cause of loss,” then it will be covered. Broad/Basic Form – if the policy does not list a specific “cause of loss” as covered, then it won’t be. Carrying General Liability in Addition to Property Coverage General liability coverage tends to be the less expensive portion of a premium, but investors may wonder why having this additional coverage is necessary when they are simply renovating a property. As a general rule, property coverage relates to the physical property, while liability relates to unforeseen events that leave the property owner open to risk. For example: If you or your realtor are showing a partially finished flip, and someone trips over exposed materials and causes themselves bodily harm, any potential lawsuits that might arise will likely name the owner of the home (which, since you’re working on the project, is you). In this case, general liability coverage will protect you. Your contractor likely carries general liability as well, but something many investors do not know is that, as the owner of the property, you still need the coverage individually and in the name of your LLC. Your contractor’s coverage only extends to bodily injury or property damage caused by their trade work. It does not insure the property you own and any claims that arise which are not directly related to them. While it can be tricky to navigate all the different options and types of insurance, choosing the plan that best fits your real estate investment project can be crucial to maximize your profits and give you a competitive edge. It is helpful to understand the choices available to you and which ones make sense for your business. Oftentimes, the options that might seem to be saving you time or money could ultimately have a negative impact on your project or business. Most importantly of all, make sure you partner with insurance providers who understand your real estate business and whom you can trust to give you the best plan for your needs.
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