Contributing Author: Mark Rogina, CPCU
Commercial property owners who lease out their buildings to others have multiple choices when designing the lease. Even after the lease is designed, further consideration must be taken to determine the execution of the designed lease.
In the event a commercial property owner has chosen to utilize a triple net lease with their tenant, the next choice to be made is how to handle taxes, maintenance, and insurance costs. The landlord has two options: 1) purchase their own insurance and pass through the cost of the policy to the tenant or 2) to allow the tenant to purchase their insurance directly.
The advantages to allowing a tenant to purchase commercial insurance for the property directly include:
- Time management is improved
- Less transactions for the landlord because of the elimination of the insurance purchase and subsequent charge-back to the tenant
While it may first seem more time and energy efficient for a landlord to allow a tenant to purchase their own insurance, there is some significant risk in the practice that the landlord may be inadvertently taking on.
Risk of Lapse in Coverage
Theoretically, a landlord could request a certificate of insurance from their tenant exhibiting building insurance. However, the certificate is only showing the coverage that is provided at that snapshot in time. A less than truthful tenant could cancel the policy after the certificate is provided or allow the policy to lapse for non-payment at some point during the policy period. In both scenarios, the landlord runs the risk of a policy not being in force at the time of loss and their property becoming uninsured.
Risk of Unknown Coverage
Leaving the tenant to purchase their own policy allows for the tenant to purchase the “cheapest” insurance option, which even if in force, may not fully protect the property in the way it needs to be protected. Is the building in a flood zone and needs flood coverage? Is it older and needs ordinance & law coverage? Is it insured to the correct replacement cost? Allowing the tenant to purchase their own policy creates a level of uncertainty in what is included in the policy which may result in a future claim being denied or only partially paid. In the event the building isn’t insured to full replacement cost, the tenant’s poor judgement in purchasing an insurance policy could lead to the landlord losing an important asset with no means to replace it.
Risk of Partial Building Repair
If a tenant is struggling to make ends meet, a higher deductible could be tempting to help offset the costs of insurance coverage and their overall lease agreement. However, if the tenant is already struggling to make ends meet, they likely don’t have enough money set aside to pay for the large deductible they chose in the event of a claim. Regardless of the size of the claim, a large deductible with no means to finance it by the tenant, could lead to a large portion of a claim going unpaid, with no cash to offset the large deductible.
If a landlord chooses a triple net lease, it’s important to understand the implications of how they’ll structure those triple net leases. Best practices would indicate that the landlord should purchase their own insurance and then charge-back the tenant for any costs associated with their insurance policy. However, if for some reason that’s impractical, a landlord should contact an insurance agent to determine the correct replacement value of their building and discuss any special characteristics of the building that may need special handling.
If you’re unsure of how to best structure your next commercial lease, or would like a review of a tenant’s policy or a quote comparison, please feel free to contact us for a free consultation.