This is a reprint from Bigger Pockets
Dave Van Horn is a veteran real estate investor and CEO of PPR Note Co., a $150MM+ company managing funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 30 years of residential and commercial real estate experience as a licensed Realtor, real estate investor, and private lender.
Fires and floods and earthquakes and landslides show how unpredictable Mother Nature can be.
Recent natural disasters have caused real estate investors to stop and think about what protections they have in place for their properties. This includes insurance, of course, but it’s about much more than that.
What is disaster insurance?
Disaster insurance, or catastrophe insurance, protects real estate properties against natural disasters and sometimes human-made events, such as rioting, terrorism, or explosions.
While these disasters are rare, their damage can cost a significant amount, which is why homeowners and property investors should cover themselves just in case.
How does natural disaster insurance work?
You might be wondering why you need catastrophe insurance if you already have homeowners insurance. Catastrophe insurance covers what homeowners insurance doesn’t. Homeowners policies cover only named perils. If a natural disaster causes damage to your property, but your homeowner’s insurance doesn’t explicitly name that type of disaster or damage, then the costs are not covered.
Often, even an “all perils” policy won’t cover some disasters. Typically, these insurance policies leave out damage due to earthquakes, mudslides, pollution, or other human-made disasters.
What types of disaster insurance are available?
Disaster insurance varies from policy to policy and insurance company to insurance company, so be sure to know the specifics of what you’re looking for. Some insurance covers the damages done by different natural disasters and human-made events. Other insurance is specialized, such as those that cover only floods from hurricanes or damage from tornadoes. It’s not unusual to have to purchase separate insurance for flood, volcano, or earthquake coverage.
Flood insurance is the most popular and is often required by lenders if the property is vulnerable to flooding. Other types of disaster insurance might be necessary depending on the locational risks, such as earthquake coverage in California. However, with flood and other types of insurance, there are caveats to the coverage you should be aware of.
- Know whether your policy covers your property or your personal belongings or both.
- Understand what kinds of damage will be covered by the policy.
- Inquire about the initial waiting period before coverage begins; flood insurance typically has a 30-day waiting period.
Thinking beyond insurance: Other ways to protect your property
This first step is a bit obvious, but when you’re purchasing a property, it’s important to assess your risk of possible property damage. It’s not a bad idea to get a Comprehensive Loss Underwriting Exchange (CLUE) report that shows a claims history of the home you’re interested in buying. These reports show if previous claims will impact your insurance rate because your insurance rates are based partly on the property’s history.
Part of your due diligence should include assessing whether a property is in a floodplain. Lenders require flood insurance when financing properties in areas known to be vulnerable to flooding. But did you know that most properties flooded in Houston, Texas, by Hurricane Irma were not in flood zones, and so they had no flood insurance?
That said, it’s a good idea to start with FEMA’s flood zone maps.
Apart from floods, ask yourself whether the particular geography of where you’re buying has extra risk. Is it in an area with a history of earthquakes, tornadoes, or wildfires? Even if so, that doesn’t make it a deal-breaker, as investors in earthquake-prone California are well aware. However, these are risk factors you should consider. Another suggestion is to look at the trees on the property to make sure they will not fall.
Consider also how the property’s construction increases or decreases weather-related risks. Is the living space elevated? Are the property’s heating and cooling systems on the ground floor or placed higher? Were hurricane straps used? Are the materials fire resistant? These are the types of concerns to consider investigating.
Homeowners insurance and reserves
In most states, landlords are not permitted to insure the contents of their properties. Instead, this responsibility falls on the tenants and is often required as part of the lease terms. For the real estate investor, this leaves them responsible for homeowners insurance and possibly flood insurance.
If you live in a hurricane-prone area, your homeowners’ policy may cover damage caused by hurricane winds but not the damage from flooding. Hurricane coverage typically requires a higher deductible than the deductibles for other types of damage; earthquake insurance is also known for having high deductibles.
That said, all policies are not created equal, and there is no one-size-fits-all insurance policy.
Lee Rogers, the president of RealProtect, suggestions asking your insurance agent these key questions:
- What is your deductible? Does it apply per property or occurrence?
- What perils are covered? Many policies offer broad or basic coverage. The perils limit what types of losses are covered. Under a special or “all risk” form, you are covered unless it is specifically excluded. Please note that floods and earthquakes are typical exclusions.
- Will you receive payment based on replacement cost or actual cash value? If you have a replacement cost, there is no depreciation withheld when you settle your loss.
- Do you have a coinsurance clause? If you’re not sure how coinsurance works in a property insurance policy, it is important to find out.
- What amount of coverage do you have in place? Is the amount of coverage you have in place adequate to repair or rebuild?
- What’s your loss of rental income coverage? Many investors also suffer a loss of income in the event of a claim. Do you have sufficient loss of rental income coverage in place if you have a covered insurance loss? Most insurers will cover you for up to 12 months of lost rental income while your dwelling is repaired or replaced.
Note that flood damage is typically excluded in a homeowners policy, so does it make sense to pay for flood insurance, especially if you own the property free and clear and aren’t required to have it? Not necessarily. As mentioned above, you need to assess your property’s risk and the likelihood of the event happening.
If you decide to buy property despite weather-related risks, or if you have properties now that you want to better protect against natural disasters, you can take steps to reduce the likelihood of damage to the property through proper maintenance as well as using newer construction methods.
For example, after Hurricane Sandy swept through the East Coast of the United States a few years ago, many residents rebuilt their properties using different methods. Many raised their homes several feet and made the first floor either a basement or a garage.
Maybe it makes sense to move utilities such as the hot water tank or the HVAC unit to the first or second floor from the basement. There are also newer construction methods that can help prevent roof damage in high winds.
Proper maintenance practices that could help prevent damage include winterizing vacant properties, updating smoke detectors, and performing routine inspections.