Making sure that your property is properly insured is especially important when that property is held for investment purposes. Assuming the investment property has a mortgage, lenders want to know that their loan will be repaid regardless of natural disasters or other unfortunate circumstances. As a borrower and real estate investor, making sure that you are not underinsured can save you thousands of dollars if the worst should happen. First, it’s key to know the differences between tax value, market value, and replacement cost.

How is the tax value of your property determined?

Tax value estimates current market value and is used to calculate the annual real estate taxes levied against the property. The local assessor looks at similar properties (comparable sales) in order to determine this estimate. In Colorado, assessors use an algorithm rather than physically inspecting each individual property, so it’s important to pay attention to the tax value that is assigned to your property and to appeal it if it seems unreasonable and you can find comps to support a lower value. Tax value can vary significantly from true market value, so it is not always a reliable determination of a property’s actual value.

How is the market value of your property determined?

Market value is what a typical, everyday buyer would pay for the property based on current market conditions. This can be difficult to determine without having knowledge of the local real estate market, which is why getting an appraisal before purchasing an investment property is so important. In the current Denver commercial real estate market, market value of industrial properties is particularly difficult to assess because many properties are selling for very inflated prices if the buyer or seller believes they can be leased to marijuana tenants. (For more about loans on properties with marijuana tenants, see our other blogs.)

How is the replacement cost of your property determined?

Replacement cost is an insurance calculation of how much it would cost to return any buildings/structures on your property to their pre-loss condition. Property owners should note that replacement cost is not an assessment of a property’s value, but simply an estimation of what it would cost to rebuild the structure. It’s important to keep your insurance company apprised of any refurbishments or improvements that are made to the property that would increase the costs of rebuilding or repairing it in the event of a natural disaster.

Second, it’s important to know what will happen in the event of a loss. Borrowers and investors should ask themselves the following:

1. Is my insurance up-to-date? If you have not revisited your insurance policy recently, it is quite possible that you are underinsured. You should update your policy to account for changes in market value and any improvements or renovations that have been made to the property.
2. What happens once the loss is reported? An insurance adjuster will survey the damage and determine whether it is a partial or total loss. This is where having updated coverage is crucial. If your property was undervalued, and thereby underinsured, then the insurance adjuster’s determination of the replacement cost might not actually cover the costs to rebuild or repair buildings/structures.
3. What role does the lender play? When a lender funds a loan against a property, they will secure their interest by becoming an additional insured. As such, they are typically paid jointly with the property owner. The property owner should carefully review the provisions in the Deed of Trust at the loan closing to make sure they understand what the lender requires in the event of a property loss.

Here are three tips to make certain that your property’s insurance policy is up-to-date and that you receive the maximum available replacement cost in the event of a partial or total loss:

1. Get or create a worksheet and provide room-by-room details of finishes and other improvements (e.g., hardwood floors, fireplaces, new cabinets, etc.) to your insurance agent.
2. Get an appraisal on the property. This will help you to reach a settlement with the insurance agency. The appraisal should be fairly recent (in the last few years) and should be re-done following renovations or improvements that will significantly impact the value of the property. Pay particular attention to the replacement cost section of the appraisal.
3. Use a phone or camera to record an audio and/or visual inventory of valuable items or improvements to the buildings/structures.

Making sure that you are adequately insured can play a big role in how you are able to bounce back after an unexpected loss to your commercial or investment-purpose property.