Insurance can make or break you in commercial real estate. Here are 5 tips to help you with this incredibly important topic:
Several years ago, one of my apartment buildings was damaged by a fire. In fact I made a video about it: Fire Burns My Apartment Building! It was a huge fire. It was breaking news at 10 o’clock and featured in the morning paper. Six fire trucks and two ambulances were called to the scene, and the Red Cross helped place half the tenants in temporary housing. The damage was so extensive the insurance claim was $1 million. And we had no cashflow from the property for six months! I’ll be honest, that night when I got the phone call, it was horrible. But guess what? We had great commercial insurance that totally covered this complete disaster. From the ground up, we built the property back up. Here's what our insurance covered:
- Mortgage payments: the insurance company paid out $40,000 a month to cover the missing rents on the property so we didn't miss any mortgage payments at all and were able to keep up with all the bills.
- Deductible: we had a $50,000 deductible, we paid that out of the $1 million claim, so nothing came out of our pocket.
- Complete Restoration: after all the renovations and restoration were complete, the units turned out nicer than before. This enabled us to collect higher rents and, as you know, as your rents go up so does the property value. So, after the fire, the property value increased.
We went from a complete disaster to complete restoration because of great insurance. Here are 5 insurance tips you need to know when investing in commercial real estate:
Tip #1: Commercial Insurance for Dummies - Know the Basics
3 Basic Definitions Beginner Investors Need to Know:
- Premium - the cost per year for your insurance.
- Deductible - is the amount of money you pay before the insurance company will pay for a loss.
- Coverage - what incidents are covered that happen on your property or to the property
3 Basic Coverages Every Commercial Property Owner Needs:
- Commercial Property Insurance Coverage - this protects the property itself.
- General Liability - this protects you or an employee if sued by someone.
- Business Income Coverage or Loss of Rent Coverage - covers lost rents every month so you can pay your mortgage, employees, and bills.
Bonus Coverage - flood, wind, and theft. What you need will depend on where you live.
Tip #2: When Not to File a Claim
Sometimes it makes sense not to file a claim for damages. For example, if you have a flood or minor water damage and that will only cost a few thousands dollars, you may want to just write that check yourself. Otherwise, the insurance company will raise your premium after a water claim, guaranteed. Because water is so intrusive and can lead to further problems, insurance companies will put you on their warning list and will look for ways to cancel your insurance policy after they pay you. By paying out of pocket you can avoid this dilemma.
Tip #3: Five Practical Ways to Reduce Yearly Insurance Costs
- Don't be loyal to an insurance company: Be loyal to your broker, but not the insurance company. We are loyal to our insurance broker, who takes our property and shops it to different insurance carriers when the policy is due. He shops annually for the best deal, getting the same coverage at a lower price. So, don't be loyal, shop annually with your insurance broker.
- Raise your deductible: The higher the deductible, the lower the premium. In a small apartment building you may have a $3,000 premium with a deductible of $1,000. If you raise the deductible to $5,000, that will reduce your premium considerably.
- Improve the safety, security, and the exterior appearance of the property: When you have commercial property insurance, a field inspector will drive by the property and look for things that may affect your insurance. They'll look for things like trees hanging over the roof and they will write up a note and send it to you and say clear this up or we will cancel your insurance. You need to be proactive about these issues, making sure the perimeter is safe. Install security cameras and alarms, and be sure the appearance is well kept so that the insurance will drop.
- Require the tenants to have renter's insurance: Renter’s insurance is a policy that the renters pay for themselves every year and is inexpensive. It covers all their personal effects so if there's ever a fire or something their insurance will cover that first before yours. Requiring your tenants get renter's insurance will drop your premiums.
- Ask your insurance carrier for discounts: We use an insurance broker for this. He is constantly asking how we can get discounts to reduce our insurance premiums.
Tip #4: Beware of the Co-insurance Clause
Co-Insurance sounds friendly like they're in it with you, right? That is so far from the truth. Insurance companies are not in it with you, they're in it to make money. The Co-insurance Clause is a rule to combat against you being underinsured and the first time you find out what it is, it may be too late. If you have a claim and you don't have enough insurance, the insurer will use a formula that diminishes your payout, meaning your loss is not fully reimbursed. In practical terms, what that means is you are penalized for not having enough insurance.
Now, why in the world didn't they tell you this in advance? I don't know. Maybe your broker wasn't good or maybe you were too cheap. I don't know what it was, but this co-insurance clause can be deadly. So, watch out and learn and understand what your co-insurance clause is in your commercial policy because all of them have it.
Tip #5: Don’t Broadcast Your Claim Amount
Keep the details of your claim to yourself and request that the claim money be sent to you and not your contractor or property manager. I‘ll give you an example of why this is so important.
We had a student investor that had a fire in an upstairs unit, and he got a check for $75,000. He went, showed his property manager, and asked him for a quote to restore and fix the unit. And guess what, the property manager gave him a quote for $75,000 to fix that one unit. Our student showed it to me, and I told him that no way was it going to cost $75,000 to fix that one unit. I advised him to go out and get his own quote.
That quote came back from a contractor for $50,000, $25,000 less than what the property manager quoted. Now, the property manager, who has since been fired, wanted to charge our student $75,000, pay the contractor $50,000, and pocket $25,000 for himself. I had the property manager get his own contractor with a bid for $50,000 so our student can pocket the extra $25,000 himself. He then used that money to do some exterior and interior work to improve the property even more.
BONUS TIP: Questions to Ask your Commercial Insurance Agent
A lot of commercial insurance agents go through the process too fast. This means they don't do a thorough job with our student investors in giving them adequate coverage. These questions are set up to slow them down and focus carefully on the coverage they are providing.
- Does this policy cover flooding? A lot of policies don't and you may need it
- Does this policy cover wind and hail damage? Many policies do not, it's extra and costs a lot so make sure to ask if you need it or not and what the cost is.
- Are there any discounts you can apply for? Often if you put security gates or cameras or make other improvements you can get significant discounts on the property, but you need to ask. Again, these questions slow the agent down to give you the best service and best coverage possible.
- What is not covered in this policy? Asking this question will really make them stop and think to ensure they are covering you properly.