Real Estate Advisor: Tenants in trouble – Business interruption insurance can help cover operating losses

March 18, 2015

As a commercial real estate owner, you know how important it is to retain your tenants. But Mother Nature, as well as other forces in the world, can make even the most solvent tenant unable to fulfill the terms of its lease.

A natural disaster, such as the landslides that have plagued the western states or the hurricanes that have ravaged the eastern and southern coasts, could inflict massive damage on a company’s facilities. Or civil unrest, such as a terrorist attack or violent protests, could leave a business owner with nothing very quickly.

In such cases, business interruption (BI) insurance can help cover your losses. Here’s how it works.

Compensation for lost income

BI insurance compensates a company for income lost when it must suspend normal operations because of physical damage to its property or a civil order requiring the business to close. Property insurance covers only physical damage to your property. But BI insurance is typically an add-on that provides money to pay salaries, benefits and extra expenses incurred (over and above those normally incurred) to mitigate its insured loss.

BI policies generally limit the period of recovery. This “period of restoration” generally runs from the date of suspension of operations to the date of completion of repairs or the date the property is returned to the same operating condition that existed before the disaster. Policy terms vary greatly. For instance, a policy may prescribe:

  • A specific period of recovery,
  • A maximum period of coverage, or
  • A maximum recovery per month.

You also can obtain extended coverage for the period between the completion of repairs and your return to normal occupancy. The policy should clearly define “suspension of operations.” Without a clear definition, the insurer might attempt to deny coverage if you don’t suffer a complete shutdown. Moreover, the insurer will cover only losses that are directly attributable to the damage, as opposed to, for example, those partly due to a slow rental market.

Evidence of losses

BI insurance aims to make commercial property owners “whole” after a disaster has caused a temporary shutdown. Policies compensate for lost rental income and costs incurred (net of operating cost savings). Some policies also reimburse for extra expenses that are incurred because of property damage.

Historic profit and loss statements, tax returns and rent rolls are used to calculate lost profits. But insurers also will factor in macroeconomic, industry and local market trends that may have lowered rental income — even if the disaster hadn’t occurred. Because indemnity will be based on your property’s financial records, make sure your records are updated and in a safe location.

To make a compensable claim, you must promptly present evidence of lost rental income. You won’t be able to recover on properties that weren’t generating rental income at the time of the damage. Remember, too, that insurers have taken a beating in recent years, and claims examiners are scrutinizing paperwork harder than ever. Many commercial property owners hire CPA firms to help support their lost profits calculations and clarify BI provisions.

Best move ever

It’s impossible to know when a disaster will strike one or more of your tenants. If your real estate firm doesn’t yet have BI insurance, perhaps it’s time to buy a policy. Doing so just might turn out to be the best move you’ll ever make.