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. What about rental property insurance? In this blog, we’re going to unpack rental property insurance and value. This is the second most major pitfalls to your rental home insurance.
Rental Property Insurance and Value
We want to jump into insurance jargon such as “Replacement Cost” and “Actual Cash Value.” However, 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…
SPOILER ALERT. We really don’t want insurance to be 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 question about what a particular limitation on his insurance meant. Why was he asking? He was reading his policy. Why was he reading his policy? Well, something bad had happened and now he was interested.
Ultimately, is insurance all that exciting? Well, compared to the Labour Day Classic, the answer is a resounding “no.” But, that’s okay! It is important. Further, if we can deal with it before something terrible happens, then that’s even better.
Recap: First Major Pitfall – Occupancy
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 now discuss is the value of rental property insurance.
There are two different ways that you can insure a home. This is whether it’s your own primary residence or your rental property. These are called Replacement Cost and Actual Cash Value.
Replacement Cost
Replacement cost means that in the event of a loss, the insurance company will pay to reconstruct your home. So long as you have sufficient insurance to do so! Further, there are a number of distinct advantages to having replacement cost coverage.
- In the event of a total loss, it ensures that you have not lost your investment. Therefore, you can rebuild your home. You can 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. So long as it is in good condition and has been updated. Finally, you must also insure to the amount to rebuild your home.
Actual Cash Value
Actual Cash Value insurance 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. This could be 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. Therefore, 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. 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. Therefore, in the event of a loss, you’re assured that with adequate coverage, your home will be rebuilt. Further, 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, you will be paid the original value. But what will that be? Neither you, us, or the insurance company has any way to project any future value. Therefore, while we would like to guarantee your value, quite frankly we cannot.
Insuring the Mortgage Amount
There is a major problem with insuring to the Actual Cash Value. 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 lot) is worth. Let’s say the home was determined to be worth $80,000 and the lot worth $70,000. Well, you would only receive the $80,000. It should be noted that this doesn’t mean you shouldn’t insure based on Actual Cash Value. We just want you to be aware of it!
Which Way To Insure?
Replacement Cost coverage is generally a better option. Although it is not always available and sometimes it is more expensive. When deciding there are some questions to ask yourself:
- Did your dwelling burn down and do you want to rebuild it? 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? What about paying out of pocket for some of the repairs? 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, 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. Your broker can help you determine what the cost to rebuild would be. Many people make the mistake of simply insuring for what was paid for. However, there is a difference between what someone paid for and what it could cost to rebuild it. Therefore, ask your insurance broker and they can walk you through the value.
Selecting the insured value becomes more challenging when opting for Actual Cash Value insurance. You need to ask what the property is worth, not what you paid for it. Sometimes we overpay. Other times we get things for a good deal. 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!
Finally, keep in mind that values change. The cost to rebuild today may be higher than it was five years ago. The same holds true to the actual cash value. It may fluctuate as well. Therefore, 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.
Talk to Your Campbell & Haliburton Insurance Broker
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 and 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