There are many considerations when it comes to properly insuring a rental property with a dwelling fire insurance policy. You must not only determine whether or not to insure the home for replacement cost or actual cash value, but also consider how you would maintain a profit margin in the event the property becomes unlivable due to a covered cause of loss.
This is where “Fair Rental Value” coverage comes into play. Many insurers will offer the option to add additional coverage to your dwelling policy, which is designed to offset the mortgage expense you incur while your tenants may not be able to occupy your property.
How It Works
For an additional insurance premium, your insurer will endorse your policy to include monetary payments in the amount of your current rental income if your property cannot be occupied.
For example, let’s say you have a $500 mortgage payment on your rental property, but charge $800 per month in rent to cover your tax and insurance expenses and still recognize a small profit.
What would you do in the event your property suffers fire damage and your tenants had to seek alternative living quarters during the repairs? Your lender, the IRS, and your insurer would certainly not allow you to take a hiatus on the monthly scheduled payments and your tenants are not going to continue paying rent on a dwelling they cannot occupy.
Fair Rental Value coverage is designed to fill the gap on the continuing expenses. The insurer will make payments, in the amount agreed to in the policy, for the time the home is not fit for occupancy. Using the example above; your insurer would pay you an additional $800 per month during the repair period.
How Much Coverage Do I Need?
In many cases, it’s a question of how much you can get. Many investors fail to consider this worst-case-scenario when operating a rental property, which is having to “float” the principal, interest, taxes and insurance out of their own pocket in the event the subject property is unfit for occupancy. This is especially true of the many thousands of investors who purchased rental properties in the U.S. real estate boom preceding the “Great Recession.”
As with any type of insurance, you get what you pay for and if you’re simply trying to locate the lowest possible premium, the policy you end up with will likely have no coverage for fair rental value, or not enough to cover your expenses for an extended period of time.
What Are My Options?
There are a few basic options available for Fair Rental Value coverage. Let’s look at some bullets.
Percentage Coverage: Many standard insurance companies will offer this as standard coverage on their policy (meaning it’s included within the premium pricing without having to ask). Twenty percent of “coverage A” is common. If your rental property is insured for $100,000, you would automatically be covered for $20,000 worth of FRV (expressed as $100,000 x 20% = $20,000).
It may be possible to purchase additional coverage from these insurers in percentage increments. For example, for additional premium, you may be able to obtain limits up to 30%, 40% or 50% percent of “coverage A.”
Actual Loss Sustained: This may be expensive, but you’re buying the peace of mind that no money is coming out of your pocket to pay for the operating expenses.
Maximum Dollar Amount: This FRV coverage agrees to pay no more than a maximum, pre-specified amount of money in the event of a covered loss, regardless of the time period. If the amount is $10,000 and the actual loss sustained is $20,000, pull out the checkbook. You’re on the hook for the additional $10,000.
Maximum Time Amount: Like the name implies, in this case the insurer will pay a pre-specified amount of money per month, for a pre-specified amount of months. If you specify a monthly rental value of $750 per month, you will receive that amount for 4 months maximum. A five month repair would leave you on the hook for $750 in principal, interest, taxes and insurance (P & I assuming you have a mortgage).
What If I Don’t Have A Mortgage?
Great! You probably still pay property taxes and insurance…
Like every other type of insurance, Fair Rental Value coverage may seem like nothing more than an extra charge from the insurance company. But remember that all insurance is considered a waste of money until you suffer a loss – then it’s the greatest concept ever imagined.
Fair Rental Value coverage may be the difference between keeping and losing a rental property in the event of a serious property loss, so be sure to speak with a local independent insurance agent to evaluate all of your coverage options when it comes time to purchase your first policy or renew existing coverage.