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How much insurance should you have for your multi-residential property?

By Christopher Seepe

Your 3-storey 11-plex investment property just burned to the ground. Guess what? Whether you like it or not (and you likely won’t like it), you are no longer a multi-residential investor. You are now a land developer.

What am I talking about? To re-construct your lost building you now have to engage an architect, project manager, subcontractors, construction manager, obtain building permits, get a construction loan, adhere to new code requirements that were passed into law since your previous building was constructed … everything you could imagine that might be required to construct your rental apartment building. This is essentially what land development is all about.

Now, being the astute investor that you are, you’ve always choked the life out of every cost in your investment to maximize your Net Operating Income. This included buying the minimum building insurance required by law or by your lender. However, the lender only cares that it can recover its outstanding loan in the event of catastrophe.

Let’s say you bought your building for $1 million and had a loan-to-value (LTV) of 75%, that is, you put in a down payment of $250,000 and borrowed $750,000. To keep your insurance premiums to a minimum, you estimate that the land is worth 20% and the building is worth 80%, so you insure your building for $800,000.

Two years later, your building burns to the ground. Assuming you have all the necessary coverages (which may not always be the case), the insurance company gives you your $800,000. During the 2 years of your mortgage, you paid down $25,000 of your principal amount, so your lender, which no longer has your building or the rental income as collateral, requires you to pay off the mortgage. The lender takes $725,000 from your insurance settlement (you likely have no choice in this—see the conditions of your mortgage). There may be other costs and/or penalties as well. So, you’re left with $75,000 to re-construct your building.

You research a rough estimate of what the cost would be to construct your new building. In Montreal and Toronto, it probably ranges between $150 and $200 per square foot. Your property is in a satellite urban centre near Toronto so you roughly estimate $140/sq ft. At 12,000 sq ft, you’ll need $1,680,000.

Two firefighters are on the second floor of a fully engulfed apartment building. This fire went 2nd alarm within minutes. The firefighters are surrounded by yellow and orange flames, dense billowing smoke, and charred wood.

Now what? You will likely have to come up with at least 35% ($588,000) as down payment. Construction financing is much more difficult and expensive to obtain than buying an existing property. Traditional banks will probably not even extend you a loan since you have no track record in land development, and private lenders charge a hefty premium over the interest rate of traditional lenders.

You’ve just discovered that you have no way to finance the reconstruction of your building and your total investment has been wiped out.

Unless you’re a large company with the financial means to finance your own re-build, DON’T GO CHEAP ON YOUR BUILDING INSURANCE.

Figure out what the real replacement cost would be of your building and pay the appropriate premium. Shop around too.

Make sure you disclose everything that you know about the building that might be considered a risk by the insurer. Don’t try to hide the item, thinking that they’ll never know. Insurance companies are in the business of not paying out for damages and will look for every means and angle they can to reduce or refuse to pay for your losses when it comes time to pay.

Don’t bother with a low deductible either. Commercial building insurance is meant to cover catastrophic events, not minor things like vandalism. If you make “small” claims against your insurance, you will likely find it difficult to get insured in the future, or your premiums will be much higher than would be expected. Every insurer will ask you to disclose whether you or the previous owner has made an insurance claim for the building in the last 5 years.

Take a high deductible (perhaps $5,000 to $10,000).

Never is it truer than when comparing insurance plans that you must absolutely ensure that you are comparing apples-to-apples. This means you have to read the mind-numbing insurance policy, consider all your possible what-if scenarios, and get the answers in writing.

Christopher Seepe is a commercial realtor, and maintains www.multiresidentialexpert.com, a website dedicated to providing expert advice and sharing his personal investment and ownership experiences to those investing, or looking to invest, in multi-unit residential, income generating properties in southern Ontario, Canada. You can contact him directly at cseepe@multiresidentialexpert.com

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