IT’S NOT AN UNUSUAL SCENARIO.
You own a commercial rental property, with a long-term tenant. Maybe it’s a retail store, maybe professional office space, or something else. The tenant decides at the end of their lease to vacate the space. Or, more likely, the tenant goes out of business. Regardless how it happens, you now have a vacant building. As a landlord, this situation requires a lot of work. Getting the property listed, completing repairs or renovations, updating the lease language, maintaining utilities, keeping an eye on the property, and figuring out how to pay the bills when there is no rental income.
Unfortunately, “I should call my insurance agent” is not typically on the top of your list when your building becomes vacant. This is a problem. Even if the building is occupied by your own company, when it becomes vacant you have a problem.
Most people are unaware that standard Commercial Property insurance policies contain Vacancy Provisions, which are activated when a property is vacant and serve to reduce or remove coverage. The ramifications from these provisions can be catastrophic, so it’s critical that you are aware of them and work with your insurance agent to mitigate them. Our goal here is to educate you on what these provisions are, and what you can do about them. Please note that I will be dealing with a standard Insurance Services Office Commercial Property insurance form, which most insurance carriers use, but it could be that your specific policy contains different provisions.
Q: When is a building vacant?
A: This might seem like a self-explanatory question, but that’s not always the case. What if you own a strip-mall building with multiple tenants, and some of the tenants leave. Is the building vacant? What if your tenant leaves, but leaves behind some of their equipment and inventory? Is the building vacant? What if you operate your business in the building, but leave and continue to use the building for storage purposes? Here is how the insurance policy defines “Vacancy” for a building that you own.
“ . . . building is vacant unless at least 31% of its total square footage is:
(i) Rented to a lessee or sublessee and used by the lessee or sublessee to conduct its customary operations; &/or
(ii) Used by the building owner to conduct customary operations.”
The two key takeaways from this definition are: At least 31% of the building’s total square footage must be being used, and customary operations must be being conducted. In other words, it isn’t enough to find a tenant to lease a small part of your building. It also isn’t enough to put a few items in the building and call it a “warehouse.” In both of these scenarios, your building is still vacant for insurance purposes.
Please note: One vital exception the policy does provide is that buildings under construction or renovation are not considered vacant.
Q: Does it matter how long my building is vacant?
A: Yes, it does matter. If your building is vacant based on the definition above, you don’t need to be concerned about your coverage until 60 days have gone by. That’s not to say you shouldn’t be concerned about your building, as vacancy brings about many increased risks. But your coverage doesn’t change until the building has been vacant for more than 60 consecutive days.
Q: What happens to my coverage after 60 days?
A: After 60 days you completely lose coverage for six specific causes of loss, which are listed below. For any cause of loss that is still covered, your claim payment is reduced by 15%. The six causes of loss that you lose coverage for are:
- Sprinkler leakage, unless you have protected the system against freezing
- Building glass breakage
- Water damage
- Attempted theft
This means that after 60 days if someone breaks into your building and ransacks it, there is no coverage. If a pipe breaks and floods the building, there is no coverage. If someone throws rocks through all of the windows, there is no coverage. If someone cuts all of the copper piping from the building, there is no coverage. You get the point. You might be tempted to think that these are relatively minor issues, and some of them are. But these causes of loss can also be severe. Water can cause significant damage, especially if not discovered for a long period of time. Water damage claims can be multiple hundred thousand dollar claims.
You also might be tempted to think that the reduction of all other paid claims by 15% isn’t a big deal. This of course depends on the value of your building and the size of the claim. If you have a $1,000,000 building that is vacant for more than 60 days and burns to the ground, you will only receive $850,000 insurance money. This can be a very big deal that can lead to a financial crisis.
Q: So what can I do about it?
A: Great question. Once you have made your insurance agent aware that your building is vacant, you really have three options.
- Add a Vacancy Permit—For buildings that may only be vacant for a short period of time, the insurance carrier may agree to add a Vacancy Permit. A Vacancy Permit is an endorsement that temporarily suspends the vacancy provisions of the policy, usually for 3–6 months at a time. This means that while the building is vacant, there is no coverage loss or reduction. Be aware that there is a premium charge for this endorsement, and typically an Underwriter will not provide it for more than 6 months or so.
- Write a Vacant Property policy—If the insurance carrier will not provide a Vacancy Permit, the next option is to move Property Insurance coverage to an insurance carrier that will insure vacant properties. There are many specialty insurance carriers that will do this, but coverage is usually not as strong, and premiums are higher than you will find on a standard Property Insurance policy. It is very important that you review the details of your Vacant Property policy, particularly the list of “Exclusions.” It is typical that these policies contain exclusions or conditions that you don’t normally find in a Property Insurance policy, so you want to be sure that you understand what these are. Your insurance agent should point these out to you and review them with you.
- Do nothing—You may decide that you’re willing to accept the risk of an uncovered loss, or a reduced claim payment, and simply leave your policy unchanged and let the vacancy provisions apply. Or maybe you feel the cost of vacancy coverage is too much to justify. As an insurance professional, I certainly don’t recommend rolling the dice with a vacant building, but it is an option nonetheless. If you do go this route, you should at the very least make sure that the building is protected as well as possible. This means doors locked, building secured, utilities and alarm systems functional, heat maintained in the winter, and a regular physical building inspection routine established. Of course, all these things should be done even if you have secured proper vacancy coverage, and some insurance carriers will make coverage contingent on them being done.
I hope it’s clear from this information that from an insurance perspective, a vacant building is a very risky asset. You want to take whatever steps are necessary to minimize the time that your building is vacant, and, above all, make sure you have notified your insurance agent if it does become vacant!