You have purchased a rental property. Fantastic! If managed correctly a rental property can be a great stream of income. So, are you ready to go? Lease? Check. Tenants screened? Done. Property manager secured? Yes. Rental property insurance? Let’s unpack what you need to know about the value of rental home insurance.
Rental Property Insurance
Before we jump into insurance jargon such as “Replacement Cost” and “Actual Cash Value” for a rental property, many of our eyes start to glaze over just reading those terms. After all that is not nearly as exciting as the latest show to binge watch on Netflix or armchair quarterbacking the Riders.
SPOILER ALERT. We really don’t want insurance to be that interesting! The only time it gets interesting is when something bad happens.
Early on in my insurance career I received a call from a client. He had a very specific question about what a particular limitation on his insurance meant. Why was he asking? He was reading his policy. And why was he reading his policy? Because something bad had happened and now he was interested.
Ultimately, is insurance all that exciting? Compared to the Labour Day Classic, the answer is a resounding “No.” But that’s okay! It may not be exciting but it is important and if we can deal with it before something terrible happens, then that’s even better.
Rental Property Insurance: Major Pitfall #2 Value
Rental homes have a couple of potential pitfalls that, if not addressed, can cause significant problems in the event of a claim. The first major pitfall for rental property owners was occupancy. The second that we will discuss is the value of rental property insurance.
There are two different ways that you can insure a home, whether it’s your own primary residence or your rental property. These are Replacement Cost and Actual Cash Value.
Replacement cost means that in the event of a loss, the insurance company will pay to reconstruct your home as long as you have sufficient insurance to do so. There are a number of distinct advantages to having replacement cost coverage.
First, in the event of a total loss it ensures that you have not lost your investment. You can rebuild your home and then decide if you want to continue to rent it out as a revenue property or to sell it and (hopefully) make a profit. You are the one who decides how you want to proceed after a claim.
The second advantage of replacement cost is the terms of what happens if you have a partial loss. A partial loss is not severe enough to completely destroy the home, but is large enough that you want to use insurance. For example, suppose you have a pipe burst that causes $30,000 in damage to the home. With replacement cost coverage the damage would be repaired for you with no depreciation.
Many insurance companies will provide you with replacement cost insurance on your rental home as long as it is in good condition, has been updated and you insure to the amount to rebuild your home.
Actual Cash Value
Actual Cash Value insurance is insurance that looks at the age, condition, life expectancy and resale value of the home. Essentially, with Actual Cash Value, depreciation is applied. In the event of a total loss, such as a fire, the insurance company will look to see what the value of the home is (not counting the lot) and will pay you whichever is lower – the amount of insurance that you purchased or the value of the home. In the event of a partial loss, such as that $30,000 pipe burst damage, the insurance company will now apply depreciation to the claim and you will not receive the full amount of the loss.
Degree of Certainty
One of the biggest advantages of Replacement Cost Coverage is that it provides you with a degree of certainty that Actual Cash Value does not. It is possible, with the help of an insurance broker, to come up with an estimated cost to rebuild the home. It is not a guarantee, but it is an estimate. In the event of a loss you know that as long as you have adequate coverage, your home will be rebuilt. You know that in the event of a partial loss, your damage will be fixed.
Actual Cash Value does not provide you with that same level of certainty. Yes, in the event of a loss they will pay you what the value was at that time. But what will that be? Neither you, us, or the insurance company has any way to project into the future what the value will be. While we would like to guarantee your value, quite frankly we cannot.
Insuring the Mortgage Amount
One of the problems with insuring to the Actual Cash Value is that there is no guarantee that you will receive enough to cover off the mortgage in the event of a loss.
Suppose that you purchase a dwelling on the market for $150,000 and take out a mortgage for $120,000. In turn you insure the home for $120,000. Now there is a loss. The insurance company will not ask what the mortgage amount is. They will ask what the home (not home and lot) is worth. If they determine that the home was worth $80,000 and the lot worth $70,000 you would only receive the $80,000. Potentially there is a shortfall.
While this does not mean that you should not insure based on Actual Cash Value, however, it is something to be aware of.
Which Way to Insure?
Replacement Cost coverage is generally a better option. Although it is not always available and sometimes it is more expensive to purchase. When deciding there are some questions to ask yourself:
- If the dwelling burned down would you want to rebuild? If the answer is “yes” you should purchase Replacement Cost Coverage.
- If you had a partial loss, would you be okay with receiving a partial settlement and paying out of pocket for some of the repairs yourself? If the answer is “no” you should purchase Replacement Cost Coverage.
The Amount of Insurance
Once you know which way you would like to insure, Replacement Cost or Actual Cash Value, the second question is how much insurance do you need?
The short answer is the full amount. But the full amount of what?
If you want to insure based on Replacement Cost then talk with your insurance broker and ask what the cost to rebuild would be. Many people make the mistake of simply insuring for what they paid for it. But there is a difference between what someone paid for a property and what it would cost to rebuild it. Ask your insurance broker and they can walk you through the value.
Picking the value to insure if you are insuring based on Actual Cash Value is more difficult. You need to ask what the property is worth, not what you paid for it. Sometimes we over pay. Other times we get things for a very good deal. Ask the question, if you were to sell the home today and receive a fair price what would it be worth? Don’t forget to subtract the value of the lot from your calculation.
Keep in mind that values change. The cost to rebuild today may be higher than it was five years ago or it may be lower. The same holds true to the actual cash value. It may fluctuate as well. We recommend reviewing your values on a regular basis with your insurance broker. Take the time to confirm that you are still insured to the correct amount.
So where does all this leave you? Call your insurance broker and ask the question: is my rental home properly insured? If it is that’s great! If it’s not, now is the time to fix it.
If you don’t have an insurance broker and want to talk to someone who is truly passionate about your rental dwellings, contact us at Campbell & Haliburton Insurance. We would love to talk to you.
Office Manager & Licensed Insurance Broker
Our Trusted Regina Insurance Agents at Campbell & Haliburton have your best interests and safety in mind and our commitment to customer service is one of the pillars of our business. We also know insurance inside and out, so please contact us for all of your insurance needs and we will be more than happy to help ensure what you value most is protected.