Whether it is a 300 unit multifamily apartment complex, large industrial warehouse, high rise office building, or popular retail center, commercial properties tend to be a hive of activity. They are places where people gather and where business is conducted, which also means they are likely places where things happen. These things – whether they be an accident, natural disaster, vandalism, or fire – are often unexpected and can have a material impact on the property’s safety, performance, and occupancy. For these reasons, it is absolutely critical that commercial property owners and investors protect themselves with adequate insurance coverage.
What Is Insurance?
Starting with the basics, insurance is a contract that protects the policyholder from financial loss when an unexpected event occurs. Under the terms of the contract, the insured party (the policy holder) pays a premium to an insurance company (the policy issuer) in return for protection from specific types of loss.
With regard to commercial real estate, the insurance needs of a property owner and the risks to them are very specific, which means that they require unique types of insurance coverage.
Types of Commercial Property Insurance
When considering the insurance needs of a commercial real estate asset, it can be helpful to think about them as a small business. Revenue is derived from tenant rents and expenses are the costs that it takes to operate the property. To that end, insurance is used to keep the “business” running or to reimburse it when an unexpected loss occurs. Depending on the size and complexity of the property, some or all of the following types of coverage may be needed:
- Commercial Property Insurance: As the name suggests, commercial property insurance is needed to protect the physical property and the equipment contained within from damage caused by things like weather, fire, theft and vandalism.
- General Liability Insurance: Commercial properties are places where people gather, which means they are also places where accidents can happen. General liability insurance protects against losses related to events that occur on the premises. Typically, this includes things like property damage and physical injury, but general liability insurance can also cover the legal costs associated with defending lawsuits that result from either of these events.
- Business Interruption Insurance: Suppose a typical summer thunderstorm spawns an unexpected tornado that severely damages much of a retail shopping center. The damage is such that tenant businesses are unable to operate, which means that they are unable to pay their rent. Business interruption insurance protects against the loss of income as the result of some sort of disaster. The disaster could be a storm, but it could also be a fire or some other unexpected event that causes a loss of income.
- Umbrella Liability Policy: “Umbrella” insurance is supplemental coverage that is designed to provide protection above and beyond the limits of the policy types described above. In other words, it may cover claims that are not addressed in other policy types for things like: injuries, property damage, lawsuits, and other personal liability situations.
- Builders Risk Insurance: Coverage for losses related to damage while a property is under construction.
- Crime Insurance: Protects against losses specifically related to crime like theft and burglary, whether they result from an unknown third party or a known employee.
- Debris Removal Insurance: Protects against the cost of cleaning up the property after a fire, flood, or windstorm.
- Ordinance / Law Insurance: Provides coverage for costs associated with demolition and re-construction of a property to updated building code standards. Typically, this occurs when an older property has been severely damaged by some other event and must be reconstructed. But, changes in building codes necessitate a complete demolition of the property and reconstruction according to the updated code.
It should be noted that the bullets above do not necessarily represent separate insurance policies that commercial property owners need to purchase. In some cases, they are separate coverages or “riders” provided under commercial property policies. In addition, some business insurance providers offer “packages” of policies designed to meet the unique needs of commercial property owners. It is always a best practice to work with an experienced insurance agent to ensure that adequate property coverage is provided.
Importance of Choosing the Right Insurer
When choosing a commercial property insurance policy, much of the focus tends to be on the specific coverages contained within the insurance policies themselves, and this is important, but is equally important to work with an insurance provider that has the financial resources to pay out claims when they occur.
Implicit in the contract with an insurance company is the idea that, in return for receiving a premium, they have the intent and the ability to pay out valid claims. This is particularly important with commercial real estate coverage because the sums involved can often be large. To illustrate this point, consider what happened in the state of Florida in 2005/2006. Over the course of these two years,7 hurricanes and 3 tropical storms made landfall in the state. 3 of these storms, Ivan, Charley, and Frances, are among the costliest in United States history with tens of billions of dollars in damage to both personal property and commercial assets. As a result, many commercial insurers collapsed, which left property owners with unpaid claims.
So, it is a best practice to research the financial strength of insurance companies prior to obtaining an insurance quote or purchasing a policy from them. This task is made relatively easy with the existence of third-party rating agencies like Moody’s, Fitch, S&P, and AM Best. While each provides slightly different rating methodologies, it is relatively simple to go to each of their websites, search for an insurance company, and analyze their rating.
Commercial Property Insurance Policy Considerations
While it is important to purchase a policy at all, it is even more important to ensure that the policy covers losses and damages that could be specifically incurred in the ownership and operation of a commercial real estate asset. To that end, there are a few key items that should be considered when purchasing commercial property coverage:
- Actual Business Income: Commercial properties come in all shapes and sizes. Business interruption coverage should specifically consider how much income the property produces when choosing how much coverage is needed.
- Potential Losses Sustained: Again, depending on the size of the property, the potential loss can be relatively small or quite large. So, it is important to consider the magnitude of potential losses, sometimes referred to as “replacement cost”, and to make sure that the property’s insurance covers it.
- Deductibles: A deductible is an amount of money that must be paid by the insured party before the insurance coverage kicks in. Generally, the premium for policies with higher deductibles is lower and, conversely, the premium for policies with a lower deductible is higher.
- State Rules: Depending on the state in which the property is located, there may be specific rules on the amount and type of coverage required.
- Terrorism: Some commercial policies exclude damage from terrorism. This should be reviewed as part of the coverage options and purchased if necessary.
Again, it is important to note that the needs of each property are unique so it is important to work with an experienced and knowledgeable insurance agent who can provide valuable insight into the separate policies or package policy that is needed based on the unique needs of the individual property.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
As part of our risk management program, we have established productive, long-term business relationships with our insurance providers and use them to ensure all of our properties have adequate coverage.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
