Make Sure Your Rental Property has Proper Insurance

Every landlord needs to insure their property.  However, the type of insurance can get confusing, but have no fear.  Your Landlord Resource has put together a guide to help you understand all the different aspects of rental property insurance.

Let’s start with the differences between a homeowner’s policy and landlord or rental dwelling policies.

Homeowners VS Dwelling Policies

Suppose you own and reside in a single-family home or a condo.  In that case, you likely are insured with a homeowners (HO) policy with coverage for liability, fire, water damage, and personal contents.  For instance, in the unfortunate event an electrical fire destroys your home and all your personal belongings from your TV and appliances to your clothing and laptop, your homeowner’s insurance policy will likely cover the replacement of these items, along with the structure of the home.  It will also provide you with another home to live in while you are displaced for repairs.  Often, if you live in a flood, earthquake, or wildfire zone, you would have to add this coverage in the form of an endorsement to your homeowner’s policy.  Your HO coverage has different levels of coverage.

Because we are focused on covering landlords and their insurance, I will not discuss the variety of HO policies offered.  For additional information, please read this article: HO3 Vs HO6 Home Insurance Policy //What’s The Difference In 2022? 

Converting Your Home Into a Rental

Now let’s say you are moving from your first home into a nicer, bigger house in a new neighborhood, but you are holding your first home to use as a rental.  Once you convert a home into a rental (which you no longer reside in), it typically is no longer covered under a homeowners policy.  Instead, the home is deemed a business, and due to the increased risk of liability, insurance companies will require you to take out a “dwelling policy.”

Do you have to have landlord insurance with a rental?  Yes and no.  If you have a mortgage on your rental, most lenders will require landlord rental insurance if the owner does not reside within the home or property.  Additionally, tenants can request to see how the rental is insured.  If the property is owned free and clear, the property owner often can hold traditional homeowners insurance, but they are taking a huge risk with liability.  In our opinion, the average cost difference of $500 a year is not worth chancing.  Be adequately insured and cover your ass-ets.

Dwelling policies differ from homeowner’s policies by which they cover the actual dwelling but usually not all the personal contents within the home.  The covered exceptions would be appliances or furniture and fixtures provided by the landlord for use by the tenant.  In addition, dwelling policies cover replacement of the structure but do not include housing for the tenant should an event cause them to be displaced.  They generally also cover a landlord’s lost rental income (up to 12 months).  Lastly, the liability coverage is typically broader due to the increased risk of strangers being on the property.  This risk is the primary component that makes the cost much more than a typical homeowner’s policy.

House Hacking

Ok, now let’s consider what you are looking at if you are a house hacker.  You buy a three-bedroom home with the intent to live in one and rent the two additional bedrooms out to tenants to help cover the cost of your mortgage.  Unfortunately, these added renters will increase the risk, and therefore, in addition to a homeowners policy, you likely will need to add an endorsement for more liability coverage.

We advise you to speak to your insurance broker to see where you lack coverage.  For example, your homeowner’s policy may allow you to have others living in the home with you, but likely their personal belongings would not be covered in a devastating event.  Additionally, your broker may suggest you take out an umbrella policy to add more liability coverage over and above what your homeowner’s policy covers.

Lastly, the tenants themselves should take out their own renter’s insurance policy to cover their personal belongings.  We require all tenants to hold a renters insurance policy if living in one of our residences.  For more information on why we insist on this, check out our blog Why Landlords Should Require Renters Insurance.

Single-Family Homes and Condo’s

Rental property liability insurance policies depend on the type and size of your rental property.  Therefore, you’ll need to advise your insurance carrier that your dwelling is a rental for single-family homes and condominiums.

Single Family Homes

Similar to your homeowner’s policy, your primary dwelling and other dwellings (i.e., ADU) on the property are covered.  It also covers personal property (fixtures, appliances, and furniture if provided for tenant use) and general liability coverage in case of injury on the property.  In addition to these items, most rental property insurance policies will reimburse for “loss of rents” should the dwelling get damaged and deemed uninhabitable due to an insured event, forcing your tenants to move out for repairs.

Condos

The only difference for condominiums is that instead of insurance coverage for the whole dwelling, it covers the insured areas of the actual unit, not common areas or the entire building.  So, walls, flooring, ceiling, fixtures, appliances, and HVAC are covered.  Additionally, it would cover liability damage that your particular unit may cause to another home, like a water leak to the condo below or vice versa, if your rental gets damaged due to an issue from a neighboring unit.  The liability coverage here is lower given the smaller area to be covered.  For instance, it’s less likely the mailman would trip over a hose and injure themselves walking around your condo than your single-family home.

As discussed above, there is a possibility of traditional homeowner’s coverage for single-family homes and condos if the owner resides there.  What if that owner’s residence is one in a duplex, triplex, or fourplex?

Multi-Family Units

Multi-family (2-4 units)

At this point, you should consider a more comprehensive policy and look towards a rental property dwelling policy.  Remember, if the property owner resides in the home, their personal property and contents are generally covered.

With each additional unit and tenant who resides in your building, your risk and, thus, cost of liability will increase.  However, given you are the owner and live within the confines of the property, your liability remains lower.  There would be less chance of wild parties and drug dealing with you keeping a watchful eye on the comings and goings of the property.  Similarly, if a water pipe bursts, insurance companies consider it more likely you would be close by to resolve the issue than if you live an hour away.

Usually, homeowner and residential policies do not provide “comprehensive” liability insurance that covers you if someone gets injured in or on the property’s grounds.  Primarily that coverage is endorsed on apartments or commercial properties with five or more units.  If you desire more liability coverage, look into adding an umbrella policy.  They can be relatively inexpensive for the coverage you get.  Typically under an umbrella policy, you only insure for the value of your property.  If you operate under an LLC, insure for the value of all assets under that company.

Multi-Family (5+ units)

Policies for apartments tend to have a broader scope of coverage.  Likely due to the increased number of residents occupying the property.  For apartments, insurance companies refer to coverage as “the building and premises,” not dwelling as for single-family homes/condos up to a four-plex.    Apartment coverage includes storage buildings, swimming pools, fencing/gates, etc., and the complex’s main building, such as where the leasing office is.

For personal property, coverage would extend to appliances, indoor furniture, tools, or machinery left on site for tenant or landlord use (landscaping tools, washer/dryer, patio furniture, etc.) as long as the landlord provided them.  However, the landlord policy does not cover a portable air conditioning unit the tenant purchases for personal use.  The tenant’s renter insurance policy covers their personal belongings.

It covers loss of income, as well as tenant move back expenses.  It’s great coverage to have when a tenant must move out temporarily in order for you to complete repairs.

Other Coverage

Equipment breakdown protection is another item your coverage may include or an endorsement you can add.   It assists to the extent that it may reimburse for expenses should you temporarily place a tenant in a hotel due to a heater or water heater malfunction.

There is pretty much insurance coverage for anything a landlord may need.  Appliances, lease guarantees, terrorist attacks, flood, wildfire, earthquake, building codes, vacancy, the list goes on and on.  Remember to weigh these additional costs against consistently saving to your reserve account each month.  Pay an insurance company for peace of mind or create ample reserves to cover way more than this one issue.

Different Types of Insurance Policies

Below you will find brief explanations of the most common types of insurance policies you would use for your rental property.  I do not discuss commercial policies for building for 5+ units as those are less common.  However, if you invest in those, you likely already understand what insurance coverage you will need.  The following focus on single-family homes, condominiums, and duplex through four-plex rental properties.

Dwelling Policies

It is important to note that different dwelling coverage levels are available.   Policies range from basic coverage to comprehensive, DP-1 through DP-3.

DP-1 (Dwelling Policy, level 1) usually will only cover named perils (typically fire).  This means that a risk, or a disasters specific identity, must be clear in the policy, or there is no coverage for the damage (i.e., water damage).   Additionally, these policies often reimburse you on an actual cash value basis, meaning that your insurer will pay you for covered damage minus wear and tear, called depreciation.  Landlords could choose this level for properties with up to four units, and we highly recommend they require renters’ insurance of all tenants.

DP-2 This form provides slightly broader coverage than the DP-1.  Like DP-1, DP-2 coverage tends to be on a named peril basis.  However, DP-2 coverage will generally extend to a wider range of perils.  For example, an insurer might offer coverage for burglary damage in its DP-2 policy but not in its DP-1.  The DP-2 form also improves on the DP-1 by typically providing coverage on a replacement cost basis, meaning that it covers damages at the current market prices without accounting for depreciation.  This factor is essential when the cost of building supplies has gone up exponentially, as have contractor fees.

DP-3.  This most expensive form provides the broadest range of coverage of the three.  A DP-3 level policy will give extensive peril coverage, protecting against all perils except those explicitly excluded in the policy.  Exclusions are usually natural disasters like floods, earthquakes, or wildfires.  Like the DP-2 policy, it provides coverage on a replacement cost basis.

Vacancy Policies

Suppose your rental property (usually single-family homes and condos) will be vacant for more than 30 days.  In that case, it is imperative you contact your insurance broker and either add a vacancy endorsement or switch to a vacancy insurance policy.  Vacant homes are much more likely to have insured events like break-ins, vandalism, water damage from broken water lines, and fire.  The problem is, if the home is vacant, most insurance carriers WILL NOT cover the damage.

We have had TWO single-family homes with such events (break-in with vandalism and flood) occur within six months of each other.  Thankfully, we had vacancy policies held on both houses.  As a result, we wrote a detailed blog about this subject: The Who, What, When, and Why of Residential Vacancy Insurance.

We suggest you check it out if you plan to remodel, go on an extended vacation, or have an unexpected vacancy that lasts longer than 30 days on your single-family home, rental or not.

Umbrella Policies

Lastly, you may consider taking out an umbrella policy.  Whether you have your properties in an LLC to protect your personal assets or not, an umbrella policy can further protect you should a tenant or anyone claim legal damages which stem from your rental property.

Even if you have an LLC, consider an umbrella policy, especially if you hold more than one property under that LLC.  Make sure your umbrella policy covers the total market value of all properties owned under that LLC.  This way, if one property has a lawsuit against it, your policy covers for the value of all properties, not just the one.

Legal action can affect all properties named in an LLC.  Therefore, it is wise to limit the value of all properties under one LLC.  The amount of coverage depends on the location of the property.  For instance, because property cost is expensive in California, the advice is not to hold coverage exceeding property values of 2 million dollars.  This higher cost means that you would not have more than three to five properties owned under an LLC and covered under one umbrella policy for most areas of California.  For some properties in the Midwest, we have heard a threshold of $550,000 is a good number.  Again, coverage for likely three to five properties would pertain to this scenario.

It also means that every time you reach your threshold, you are creating a new LLC to which you would add any new properties, thus opening a new umbrella policy for the value of those properties under the new LLC.  The more properties you own and the higher the value of those properties is, the more risk you hold should a lawsuit arise from one property.

Let’s consider the following scenario:

You own five properties that, when you purchased them, were worth $100.000 each.   You took out an umbrella policy to cover these homes with coverage at $500.000.  Several years pass, and a dog you allowed your renter to have on the property gets out and attacks the child that lives next door.  There are expensive medical bills and emotional damage, and this family wants compensation.

The parents of that child will not only be going after the renter, who likely has little savings or protection, they will also go after the property owner who allowed that dog to live on the property.  They are suing for one million dollars.  Now, your umbrella policy when you first took it out for $500,000 remains the same.  Still, due to appreciation, your property values are now worth $200,000, and you find a half-million-dollar gap between market value and coverage.  Guess what?  A judge could force you to sell off three properties to cover that gap should the court find you liable.

This scenario is a perfect example of how owning and operating a rental property business is NOT passive.  There will constantly be assessments and evaluations that need attention, and insurance coverage is only a tiny part of that.

Other Items to Note

Rental Property Insurance Cost

Insurance expense is a huge factor for landlords.  If you want to buy or convert a home into a rental property, you must research the cost before calculating your expenses.  Do not rely on the amount shown in the offering memorandum/disclosures or provided by the current owner.  Most realtors will post lower cost estimates or use the (often outdated) policy amount in their marketing to help the property yield a higher return.  FYI, this is sometimes true of property taxes as well.

Rental property insurance can cost up to 25% more than a typical homeowners policy.  For example, in early 2022, the average homeowner policy is/was $1,680, which would make the average landlord or rental property insurance for a single-family home around $2,100.  If you do not account for the difference in the rates and are only yielding $100 a door, this $35 increase can break your bottom line.

By the way, apartments with five or more units are commercial policies, and the cost will be exponentially more expensive than a single-family home through four plex-sized units.   To give you an idea, we spend upwards of $6,000 annually for our six-plex, which also happens to fall in a flood zone.  Even though the location of this property is in Midtown of a major metropolitan city, we opted not to take out “terrorist” coverage to cover damages from the result of riots, etc.  For us, the risk was not worth the added expense.

Be Buddies with Your Broker

Each insurance company has different levels and forms of coverage.  It is a good idea to have a conversation with your broker to assure your rental property insurance coverage is satisfactory.  In addition, ensure you know what exclusions apply to your policies.  Inquire about what endorsements you can add to cover those exclusions.  Your broker is an integral part of your rental property team.  Make sure they are not just there to collect the annual policy rate.  They must meet with you at least once a year to make sure your coverage is adequate.  To learn more about the importance of developing a good team, read our blog Landlording Is A Team Sport.

Become friends with your broker.  This way they know when changes happen and can better advise you how to handle the insurance side of things.  Our close relationship with our broker is how we discovered vacancy insurance.  An immediate family member lived in one of our single-family homes.  When I called to let our broker know of this person’s death, he advised we switch to a vacancy policy.  Several months later, someone broke into the home and vandalized it.  Thankfully we updated our policy, so the insurance company paid for the damages.  Unfortunately, most home insurance policies (rental or not) will not cover damages to a vacant house.

Whew!  That is a lot of information about rental property insurance to absorb!  We hope you can decipher what coverage you may consider for your rental property.  Please note!  We are not in the insurance brokering business.  In no way are we stating what you need for insurance coverage.  Our blogs are purely informational.  Take this information to your insurance broker and decide what is best for you.

Check out our other blogs to guide you on your self-management journey as a landlord:

Long-Term or Short-Term Leases, What’s Better For Your Rental Property?

How To Improve Tenant Relations

Security Deposits: 5 Tips Landlords Should Know

Meet Stacie & Kevin, Your Landlord Resource

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