Rental real estate is one of the most rewarding investments ever, featuring the dual advantages of rental income from tenants and long-term capital appreciation. However, as risk is never far from reward, a landlord must be adequately protected from the unexpected — and that means insurance for landlord liability.
If you think that once you find a good tenant for your property your troubles are over, please think again. If you’re a landlord, you need to understand the unique risks you face. And more important — how to protect against them.
Rental real estate risks
Since other people are living on your property—and also since you may have employees and contractors on premises—a landlord faces very different risks than the typical homeowner. When you own real estate, you really own a small business. According to the American Apartment Association, a landlord faces at least nine identifiable risks:
- Fire, storm and other catastrophic losses
- Liability for tenant and employee injuries
- Tenant or employee theft
- Malicious damage and vandalism by tenants
- Loss of rental income
- Libel, and slander by employees against tenants
- Discrimination lawsuits filed by disgruntled tenants and employees
- Allegations of fraud, misrepresentation and other intentional acts by employees
- Claims made that exceed insurance policy limits
As an example, a landlord is liable if an accident or injury occurs on the property that was caused by a dangerous property condition or by inadequate maintenance. In such a situation, a tenant can sue for damages. However, there is specific insurance coverage (landlord liability) designed to protect against such a suit. In fact there is coverage available for nearly any type of liability a landlord might face.
A standard homeowner’s insurance policy will prove inadequate if you own rental real estate. At a minimum, investment property should be covered by the following policies.
Property and Casualty Insurance. This type of policy covers residential property owners from fire, storm or other catastrophic losses that could make the property uninhabitable. It is typical coverage for owner-occupied homes and rental properties. Specific casualties include fire, severe weather and vandalism. Coverage can be based on either replacement cost or actual cash value and should also include an inflation provision to allow for rising prices.
Coverage can also extend to “secondary structures”—detached garages, tool sheds and other “out buildings.” The policy should cover secondary structures equal in value to 10% of the main structure, but it can be higher if needed.
Rent loss insurance. Property and casualty policies will cover damage to a property for catastrophic events, but a separate policy will be needed to cover the loss of rental income as a result of the disaster. Rent loss insurance will accomplish this and enable you to maintain a cash flow to pay the ongoing expenses of owning the property. Coverage should be for an amount equal to your monthly rent income for up to twelve months.
General Liability Insurance. General liability insurance covers landlords from lawsuits caused by accidental property damage or injury, such as those incurred by tenants or by an employee of the landlord. It typically covers negligence and general liability, but not intentional acts such as fraud or arson. Consider buying employee disability insurance as a separate policy.
Umbrella Insurance. Beyond the coverage listed above, a landlord can also purchase either a personal or commercial umbrella insurance policy. This gives the landlord excess liability insurance coverage, over and above what is provided by general liability insurance.
Still another type of coverage that’s sometimes (but not always) needed is flood insurance. Property damage caused by flooding is not covered under typical property and casualty policies. This type of insurance is necessary if the property or any part of it is located in a flood plain, as designated under the National Flood Insurance Program. If it is, mortgage lenders will require that flood insurance be maintained on the property for the full term of the loan.
A single casualty or lawsuit can turn a profitable real estate investment into a financial nightmare. But most disasters that an investor will face can be covered with adequate insurance. If you’re a real estate investor, or plan to be one, make sure you have all that you need. Not only will it provide protection against potential financial hazards, but it will also provide the peace of mind that every investor needs in order to profitably manage his or her property.
Kevin Mercadante is a professional personal finance blogger and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids.