My insurance agent says the homeowners policy won't cover a rented second dwelling

Question

I called my insurance agent to ask what happens when the backyard unit is done and she said the current homeowners policy won't cover a rented second dwelling, that we'd need to restructure it, and that she'd have to check whether her carrier writes two dwellings on one lot at all. Then a contractor mentioned in passing that the permit goes to the county and the county tells the assessor, so my property tax goes up.

I had both of those at zero in my spreadsheet. I've been modeling $1,600 rent against the loan payment and maintenance and nothing else. What actually changes on the insurance and the tax side when a rented ADU exists, and roughly how much do people see it move? I'd rather find the number now than after the framing.

Rena Guide · Accepted Answer

Both of those are real and both are findable before you build.

On insurance, a standard homeowners policy covers your residence and unattached structures like a shed or a detached garage. A second dwelling that someone pays rent to live in is a different exposure, so carriers handle it by adding an endorsement to your existing policy, by moving you to a policy form that contemplates a rented unit, or by writing the ADU on its own dwelling policy. Which of those is available depends on the carrier and on your state's filed forms, so ask your agent for the specific option in writing along with the premium. Two things worth asking for at the same time: enough dwelling coverage to actually rebuild the ADU at today's construction cost, and loss of rents coverage, which pays the rent while the unit is unlivable after a covered loss. Also tell the insurer during construction, because a building under construction is usually covered by a builder's risk policy rather than your homeowners policy.

On tax, the mechanism in most states is that the assessor adds the value of the new improvement to your existing assessed value rather than reassessing the whole property from scratch. Some states have specific protections or exclusions for small ADUs and some don't, and this varies state to state, so call your county assessor and ask how they treat a new accessory dwelling. They answer that question all day.

If you want a placeholder while you wait for real quotes, carrying a few hundred dollars a year of added premium and a tax increase tied to your build cost will keep you from being surprised in the wrong direction.

Rena Expert · Answer

Insurance on an ADU usually moves more than people budget because the replacement cost is real. A 640 to 800 square foot detached unit that cost $180,000 to build costs at least that to rebuild, and the carrier prices coverage off that figure, not off the rent. Ask what the premium looks like at full replacement cost on the ADU, then ask what it looks like at the number the carrier's own cost estimator spits out, because those two often disagree and the low one leaves you coinsured on a partial loss.

The tax side is more predictable. If your jurisdiction adds assessed value roughly in line with construction cost and your total effective rate is around 1.2 percent, a $180,000 improvement is on the order of $2,000 a year, or about $180 a month against your $1,600 rent. Confirm your own rate and your assessor's method, since some states cap annual increases and some treat new construction as a separate event outside the cap.

What I'd add to your model is the piece that isn't on a bill. Once a tenant lives on the lot, your liability exposure has a resident in it. Check your umbrella policy actually extends to rental activity at that address, since some exclude it, and check whether your carrier requires anything specific like a hard-wired smoke and CO setup or a handrail spec to keep the unit insurable.

And get the tax number from the assessor's office rather than from the contractor. Contractors are wrong about this constantly, in both directions.

devon_pierce · Answer

Adding a line to my own worksheet for this. So the realistic view is rent minus debt service minus taxes minus insurance minus maintenance minus vacancy, and the $1,600 headline number is maybe $1,100 of real money before a single repair?

dpatel_re · Answer

bramble, closer to $1,000 if you hold 5 percent vacancy and 8 percent for maintenance on a new build, which is generous because new construction is cheap to maintain for the first several years and then isn't. The reason ADUs still underwrite well is that the land is already paid for and the loan is often sitting behind a low first mortgage rate. Take that away and the numbers look ordinary.

wendy_park48 · Answer

Pull your actual homeowners policy and read the definition of "residence premises" and whatever the exclusion for business or rental activity says. Mine excludes any structure rented to someone who isn't a residence employee, in plain language, three lines long, and nobody ever reads it until there's a claim. The endorsement your agent is describing exists to fix exactly that sentence.

sonia_alvarez · Answer

One more paper trail item: if you're financing the build, the lender will want to be named on the builder's risk policy and then on the permanent policy, and a mismatch between the address on the policy and the address the county assigns the ADU has held up funding before. Ask who assigns the unit number.

derekj19 · Answer

Does the tax increase come the year you pull the permit or the year you finish? My city inspects, signs the final, and only then does the record change, which was a full year of lag.

mitchell_ray4 · Answer

beacon, in the counties I've done work in it hits when the certificate of occupancy is issued, and it gets prorated from that date. But the assessor's office is the only one who can tell you for yours, they all run it differently.

priya_n21 · Answer

This is the part that keeps pushing me toward just buying something already built with a legal second unit. Somebody already ate the permit, the reassessment and the insurance rewrite.

ehernandez74 · Answer

marlow, that's where I keep landing too, though you pay for it in the price. The already-legal two unit properties in my area trade at a premium that's bigger than the build cost, which is odd until you realize the buyer is paying to skip 14 months of permitting.

tylerbrooks9 · Answer

Windlass, did your agent say whether the carrier would keep you at all? That's the answer I'd want first. Being non-renewed after the unit is finished and having to shop the whole property in a hard market is a worse problem than a higher premium.

My insurance agent says the homeowners policy won't cover a rented second dwelling

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