Real Estate Insurance 101: What Is Insurance & Why Does It Matter?

For anyone considering becoming a real estate investor, one word comes up repeatedly: risk. Real estate can build long-term wealth by generating cash flow, appreciation, and tax advantages. At the same time, it exposes investors to financial risk. Insurance exists to help manage that risk.

This guide covers the very basics of insurance in real estate, including what it is, how it works, the two main types of risks in real estate, and why it matters.

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What Is Insurance in Real Estate?

Insurance in real estate is a contract between a property owner and an insurance company. The purpose of this contract is to transfer risk from the owner to the insurer. In simple terms, real estate insurance provides financial protection for property owners. It protects them if something unexpected happens to their property or if someone claims they caused harm.

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How Does It Work?

Insurance works through a risk-transfer agreement between a property owner and an insurance company. The owner pays a premium, usually monthly or annually. In return, the insurance company agrees to financially protect the owner against specific risks listed in your policy.

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Here is the process in simple terms:

1. The property owner purchases an insurance policy. The insurer evaluates the property and sets terms based on risk factors such as location, building type, condition, and claims history.
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2. The property owner agrees to the coverage terms. The insurance policy outlines:
   
   • What events are covered (for example, fire or certain types of storm damage)
   • The coverage limits (the maximum the insurance company will pay)
   • The deductible (the amount the property owner must pay out of pocket before insurance applies)
   • Any exclusions (what is not covered)
3. The property owner pays the premium. The premium is the cost of the insurance policy and must be paid to keep the coverage active.
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4. If a covered loss occurs, the property owner files a claim. The insurance company investigates the claim and, if it is approved, pays for covered damages or legal costs up to the policy limits, minus the deductible paid by the property owner.

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What Type of Risks Does It Cover?

Real estate investors face two main categories of risk: physical property risk and liability risk.

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1. Physical Property Risk

What It Is: Physical property risk involves damage to the building or structures. Common causes include fire, storms or wind damage, vandalism, and certain types of water damage.

What Insurance Does: Property insurance covers the cost to repair or rebuild the structure if a covered event occurs, protecting the property owner’s investment.

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2. Liability Risk

What It Is: Liability risk involves legal or financial responsibility if someone is injured or their property is damaged because of the property owner’s building or operations. Common scenarios include a tenant slipping on icy stairs, a visitor being injured by a loose railing, or damage caused by a contractor during renovations.

What Insurance Does: Liability insurance helps cover legal defense, settlements, or court judgments related to these claims, shielding the property owner from potentially large financial losses.

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Why Is It Important?

Real estate is often a leveraged asset, meaning most investors use borrowed money to purchase property. Lenders require insurance because they want to protect the building that secures their loan. If the property is damaged or destroyed, the lender still expects to be repaid.

But insurance is important for more than just meeting lender requirements. It protects both the property owner and their investment as a whole. If something unexpected happens, such as a fire, storm, or liability claim, insurance helps cover the resulting costs. This protection ensures that both the investment and the owner’s personal finances remain secure.

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Disclaimer: This content is meant for informational purposes only and is not intended to be construed as financial, tax, legal, or insurance advice.