by Mark Gannaway, CPCU Arcana Insurance

If you have not reviewed your insurance values in your current portfolio in the last 6 months, you are probably underinsured and will not meet the 80% requirement to have replacement cost on your properties.

Back in the summer of 2018, I wrote an article for the RE Journal saying, “It’s no secret, the days of purchasing single family homes for investment purposes has become extremely competitive and challenging for the average buyer. No doubt it’s a sellers’ market, especially in major metropolitan areas like Atlanta, Charlotte, Chicago, Dallas-Fort Worth, Phoenix, Portland, and Tampa-St. Petersburg with values appreciating in the last 12 months 8% to 25%. Overpaying for a property typically leads to an unsuccessful ending, especially if you’re financing the property with a lender.”

Little did I know in the middle of 2021 I would still be writing about the same topic but with an added twist, the cost of inflation when it comes to settling an insurance claim. Yes, it’s still a seller’s market in most parts of the country, but when it comes to building materials and labor costs, it’s a nationwide problem.

For example, recently, in Frisco, Texas, admittingly one of the hottest places to live in the USA right now, a single-family resident put their house up for sale due to job transfer and received 92 offers in 24 hours. They accepted a cash offer of $60k over their asking price. If that was an investor purchasing the home, two immediate problems come to mind, financing and insuring the investment at the purchase price. I’m sure the appraisal, no matter how generous, would not meet the lender’s requirements and secondly, insurance companies may only insure the property for replacement cost, not the sales price. Insurance companies are not obligated to pay over what it would cost to “replace” the damaged property in most cases.

With hot real estate markets, comes media outlooks applauding “seller’s” while hardly mentioning the negative impact, especially the increased cost of living and doing business in these communities. As I mentioned earlier, with material goods and demand for labor across this country already in high demand, imagine what it’s like in a hot real estate market. Inflation rates in these areas are well above the national average.

Prices for lumber have risen 40% in the last 6 months; concrete is up 200 to 250 percent during the same time frame. And that’s if you can find it. Contractors have lost most of their labor force not to contractors who will pay more but to government relief packages that match their working pay if they stay home. All these cost components have a negative impact on the cost per square foot to replace the insured damage.

To receive Replacement Cost insurance coverage, the insured property, in most cases, must have at least 80% of its replacement cost value insured to receive this benefit. A lot of insurance companies, especially homeowner insurance companies require 90%. So, if you have a single-family residence that has a replacement cost value of $100,000, the insured must purchase an insurance policy for a minimum of 80% or $80,000. In this example if you insure the property for $75,000 the insurance loss is paid at Actual Cash Value (replacement cost minus depreciation). That can add up quickly.

To increase insurance values, you will need to speak with your insurance agent and ask them what the process is to make sure you have the proper insurance values in place. And while you have them on the phone, go ahead and ask them what’s the current construction replacement cost on a per square foot basis in the area where you are purchasing homes, not the sales or appraisal price, but the construction replacement cost. If they don’t know, ask your contractor.

Purchasing an investment property and not being able to insure it for its full purchase price creates sleepless nights for most investors and insurance agents. And, as always, the information provided to you above is for informational purposes only. Please read your insurance policy carefully and consult an insurance expert before buying or changing your insurance coverages.

It’s also a time when I am reminded that having a good insurance company insuring my home, automobiles, business, and other investments are very important and that paying less expensive insurance premiums doesn’t always equate to saving money.