What is leasehold interest insurance?
One of the most undersold commercial property coverages: Leasehold Interest
Have you ever heard of Leasehold Interest Coverage? Most likely not. In fact, many insurance agents do not know about this coverage either.
There are a lot commercial properties becoming available after COVID 19. Since employees of businesses are able to work remotely, many commercial properties are becoming unoccupied or vacant. Because of this, many landlords are willing to accept lease terms that are very favorable to their tenants.
Let’s say you are able to negotiate a favorable lease. A lease where the rate is substantially less than the normal comparable rates available in the local commercial real estate market. Regardless the reason that you were able to negotiate these terms, you may have a lease rate that can not be replicated in the local real estate market.
Losing the favorable lease can result in an unplanned increase in operational expenses for may years following the actual damage and the business’ return to operation.
Assume market prices in the area are $15 a square foot and your rate is $10 a square foot. You have a 5 year lease. But the end of year 1, there was a fire that severely damages the building, resulting in your lease being cancelled. Your lease was for 20,000 square feet. Your lease now jumps from $20,000 to $30,000. The monthly rent difference translates into an additional $120,000 in operating costs annually due solely to increased lease payments. Even if you only had 2,000 square feet that is still an annual expense of $12,000.
Remember those numbers are annual, so if you still had 4 years on your lease now you are talking $500,000 or $50,000 respectfully.
So, what does leasehold interest coverage do?
Leasehold interest coverage protects against the financial consequences of an indirect loss arising out of a direct loss.
Three conditions must apply to leasehold interest protection
- There must be direct property damage
- The damage must result from a covered cause of loss
- The loss leads directly to the cancellation of the favorable lease
Four exposures can be covered by leasehold interest coverage form
- Tenants lease interest
- Bonus payments
- Tenants improvements and betterments
- Prepaid rent
Tenants lease interest– is the difference between the rent/lease the tenant pays and the market value applicable to the premises. It is not the amount of coverage purchased, the net TLI is a function of the time value of money
Bonus Payment– A bonus payment is nonrefundable money paid by the tenant to acquire the reduced lease. For example, the owner, is aware that they are charging lower rent, but they are willing to do so if an additional fee (not the security deposit) is paid up front.
Tenants Improvements and Betterments are additions or upgrades made by the tenant to the building. Once these are made part of the building, they can not be removed and those become the property of the building owner. The coverage protects the tenant from its loss of use interest in the property. If the tenant’s betterments and improvements are separate and specifically insured then they would not be part of this coverage.
Prepaid Rent, rent paid by the tenant in advance, that is not returned, even if the lease is cancelled.
When you have leasehold interest coverage it should be reviewed at least every 2 years, because the market value of property fluctuates over time. So, therefore the lease may be even better 2 years later, or not as good. Having an annual conversation with your agent to go over this coverage is recommended. That is why we ask for annual reviews with our customers to discuss their coverage and what has changed.
Call Huff Insurance Today
Call us at 410-647-1111 to discuss your commercial insurance needs. We will work with you to come up with the best insurance plan to protect your business.
**Insurance coverage varies by state and by company. Please verify your actual insurance coverage availability with your insurance agent and/or insurance company.