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As a private lender for over twenty years and riding through various cycles, I’ve seen it all in real estate. There is one preventable mistake that is made by property owners that always surprises me. It is such an easy task and doesn’t cost much money but can save you financially. Have you made this mistake? What steps should you take today to ensure you don’t end up in financial ruin due to your real estate?
Summertime is a good reminder of the number on mistake people make in real estate. Not having enough insurance on their property. Why is this so critical?
Case Study in Financial Ruin:
About five years ago a major wildfire destroyed many homes in Black Forest (not far from Colorado Springs). We had done a loan on a residential investment house (rental) for a borrower a few years prior. Our loan amount was $150,000 and the property was worth around $350,000. On all our loans we require property insurance. The borrower had a residential policy for $150,000. In 2013 a wildfire quickly destroyed hundreds of homes in the area including the property we had a loan on. The house was a total loss burned to the foundation.
What happened after the embers cooled?
Our borrower filed a claim with his insurance company for the maximum amount on the policy, $150,000. The insurance company paid this amount to the borrower and the lender. The $150,000 was not enough to rebuild the property. The borrower paid off our loan of $150,000 and was left with a residential lot that needed about $25,000 in cleanup due to the fire. The lot is worth maybe $30,000 as there is little demand for a vacant lot that has zero trees in the area and likely a contaminated well due to the fire.
The borrower effectively lost $200,000.
Our borrower effectively lost his property and $200,000 in equity due to the fire only to be left with a contaminated lot. There wasn’t nearly enough money to rebuild the property.
This can’t happen to you; think again!
Last year a wildfire threatened the entire town of Breckenridge (near peak 2). This was not just residential properties but the entire downtown district. A fire a few weeks back in Summit county came within 200 feet of 1300 homes. Colorado springs had one not long ago within the city limits destroying hundreds of homes. This same scenario has played out throughout Colorado including Boulder, Evergreen, Golden, Parker, Castle Rock, etc… The risk is real to both residential and commercial property owners.
How can you prevent making the same mistake?
It is much more expensive to build a new house today than it was in the past. Building codes have changed, materials and labor are more expensive, and land use requirements have also changed. All of this adds to increased costs if there is a major disaster. Many times, insurance does not keep up with the fast increase in costs.
You, as the property owner, have the burden of updating your policy to ensure the correct coverage. If you are under insured, you are out of luck if the policy is needed.
Ensure you have the proper coverage.
When checking on your insurance it is imperative to focus on replacement cost. The amount of coverage you need is not what the house would sell for or what the tax assessor thinks the house it is worth. You need to have ample coverage to actually rebuild the residential or commercial structure. This number could be radically different than the tax assessment or the market value.
What is replacement cost?
This is an insurance calculation that specifies how much a building/structure would cost to replace at its pre-loss condition. This number is basically the amount it would take today to rebuild/repair a property if it were damaged. It is important to note that the replacement cost is not “what your property is worth”, it is merely a calculation of what it would cost to build the house. To accurately determine replacement cost of a property an agent goes room by room assessing the floor coverings, building construction, finishes, etc… The replacement cost number is typically only important in a loss situation and/or to set your current insurance rates.
How to determine replacement cost?
Most insurance companies have a worksheet that they provide to have you specify details of each room (construction type, floor coverings, fireplaces, materials used, etc..) to get an accurate picture of the rebuild cost. Many insurance companies can also send out an adjuster to help calculate this for you. When I purchase my house, I went this route and walked through the house with an adjuster my replacement cost was about 20% higher than what I had just purchased the property for. You should re-look at the value every couple of years to ensure it is keeping pace with building costs.
What should you do?
Will you make one of the biggest real estate mistakes? Will you become a “case study” for what happens when you and/or your business properties are under insured? A few simple steps can prevent financial ruin. Now is the time to act to ensure you replacement cost is updated. Although, it is a very simple process that doesn’t take much time or cost, I’m still amazed at the number of people that take such a huge financial risk being substantially under insured for little to no upside. Will you take the risk or will you take the necessary steps to protect your financial health?
I need your help!
Don’t worry, I’m not asking you to wire money to your long lost cousin that is going to give you a million dollars if you just send them your bank account! I do need your help though, please like and share our articles it would be greatly appreciated.
Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is the recognized leader in Colorado Hard Money and Colorado private lending focusing on residential investment properties and commercial properties both in Denver and throughout the state. We are the Colorado experts having closed thousands of loans throughout the state.
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