Vacany Insurance: The Product You've Never Heard of

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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What is Vacancy Insurance?

When purchasing in any area part of due diligence is always to find out what typical vacancy rates are in that area. If the rates are high it means there is a saturation of supply with low demand and it may be a good idea to rethink the area you are purchasing in. Having said that, sometimes that type of area can also be a source of the best deals. If you are a really good property manager, or have one working for you, and are willing to make the property more appealing than those around it, you may have a great opportunity on your hands. In Canada the best way to check up on vacancy rates is by looking it up on CMHC. This website has a TON of information that is useful, but you'll need to learn to find and sift through a lot in order to get the most out of the site. There are some other quick checks you can do on how much of an area is purchased for rental vs. owner occupied dwellings. One app I would recommend for the quickest of checks is CIBC's "Home Advisor". This app is free for the iphone, but isn't the absolute most reliable in information. So, use it for a quick preliminary check and then do your proper due diligence on the area.

The reason you've never heard of vacancy insurance is that it isn't purchased all that often. To tell you the truth, I have no idea whether it even exists in the form other insurance plans exist. I would never purchase this for myself however, because I self-insure for vacancy risk. When a property sits empty for even one month the expense can be enormous. I'll give a typical example:

You have done your homework and have purchased a suited single family detached house that brings in about $2,300 each month and only costs you $2,100 in expenses (including vacancy self-insurance and all other expenses I've previously discussed in my blogs). Great deal, right?! It absolutely is a great deal, better than almost all investors in Canada. If this property sits empty for even one month, however, you have just gone in the whole $2,100! With an average of $200 each month in cash flow it will take almost an entire year to make that up. The way to insure yourself against this risk is by taking out a little bit of money each month so that when it happens (not if... when) you will be covered and it won't affect cash flow at all. Is this possible? Yes.

An Alternative to Self Insurance

There is always the option of simply raising rent... Isn't that a great idea? This way you will make more when the property is filled and the hit when it is empty doesn't feel so bad. FORGET YOU EVER HEARD OF THIS OPTION! The reason this is an absolutely crazy idea is that by keeping rents higher then the average in your market will guarantee you will have more vacancies. While I don't advocate charging less than market rent under normal circumstances (again, this is a topic for another blog), there is a better way ta take care of vacancies.

Two Legitimate Ways to Manage Vacancies

The first, and best, way to manage vacancies is not to have them. If the average vacancy rate in your area is 4%, you should always have a less than 4% vacancy rate, period. This should be the case if you self manage and if you hire a property manager. Demand this of your manager and then pay out bonuses for reaching that rate year after year or, conversely, penalize the manager for not reaching that rate. I believe I've mentioned this in a previous blog but it should be repeated often. I know a manager who has a better than 4 year average on a tenant turnover. Not only that, but I believe this individual rarely has vacancies when the turnover takes place. What this means for you, the property owner, is that you don't deal with as many headaches (putting new tenants into a property), as much payout with turnover (each time a new tenant comes in there is risk of more damage to the property than what the security deposit covers), or as much expense cost and loss of cash flow when there is a vacancy of one month or more. Again, this is subject matter for another blog, but there are great ways to reduce the chances of vacancies and length of vacancies. Bottom line... beat the average.

The second way to manage vacancies is to build them into your expenses. If the average vacancy rate in your area is 4%, then take out 4% of the rent for vacancy expenses. For the same $2,300 in rent that was used as the example above, $92 can be taken out each month to become your vacancy insurance. Every 2 years (25 months to be exact) you will have enough in the account to cover one month of vacancy. The way I take care of and build expenses into my evaluation of any property has 2 great advantages. The first is that I never purchase a property I can't afford. The second is that if every thing goes wrong that typically can go wrong in a property it doesn't affect me negatively because I was expecting it. On the other hand, when something doesn't go wrong (if I have 10 years of owning a property without one month of vacancy) I now have cash sitting in an account that I can use for whatever I want. This is now my bonus for managing a place well and it isn't difficult to beat the average.

A Teaser

I'll give one really quick tip on filling a property quickly and avoiding vacancies. In your lease contract you can offer an incentive for letting you know at least 30 days in advance when your tenant is leaving. If your tenants gives you more than 30 days notice you will give a discount of some kind off the last month's rent. It should be clear that your tenant must still pay the last month's rent and that this discount will not come out of the damage deposit. You can also set the date at 45 days if you would like to do so. What this does is give you, under normal circumstances, more than 4 week's notice and allows you to find a really good next tenant. It costs you nothing if the tenant doesn't give you notice (without penalizing the tenant either) and really doesn't hurt if you find an excellent tenant well before the vacancy. Also, many responsible tenants look ahead of time for a property. Finding these people early can snowball into having better tenants that do less damage, pay on time, and let you know well in advance when they are planning anything like moving out.


Here's to your future of risk-averse investing!

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html