The Northridge earthquake has resulted in billions of dollars of property damage. Insurance, private assistance, and public assistance do not bring order to the chaos suffered by private investors, who must now repair or restore their property and hope to recover pre-earthquake levels of income stream and equity.
To the property owner with no Earthquake insurance or with typically high deductibles, the prospect of recovery may seem insurmountable. But sources of recovery and legal strategies are available to salvage an investment.
Apartment owners whose buildings suffered earthquake damage are in a quandary over the following predicaments:
1) Some or all of the units may be uninhabitable, reducing the income stream. This not only affects the owner's cash flow, but probably makes it impossible to pay monthly mortgage installments.
2) The owner did not have Earthquake insurance or has a deductible that the owner is incapable of paying. In the latter case, even Earthquake insurance payments that are available can't kick in because the deductible is too high for the owner to pay-putting off repair of the property and thus prolonging the economic stoppage.
3) Through various forms of assistance, the owner may be able to borrow the money to make necessary repairs (or pay the deductible portion of any insurance). This, however, increases debt service on the property and reduces the owner's equity. In the current depressed real estate market, this increased debt service could result in negative cash flow and loss of a substantial portion of the equity.
There may be alternate policies that can be used to repair earthquake damage. Or third parties may be liable to the owner for some or all of the earthquake damage.
Know Your Coverage
Owners must know exactly what kind of insurance they have. Frequently, the only part of the policy that the owner retains is the declaration page, which lists the name of the insured and the amount and types of coverage. Often, insurance agents send only the declaration page when the policy is renewed, thinking it's unnecessary to give the insured another copy of the policy being renewed. However, a renewed policy can vary in its terms. The standard declaration does not describe the particular rights of the insured. Before doing anything else, a policyholder must obtain the printed multi-page form of the policy.
An owner who does not have a copy should insist on getting one from the agent. If the agent does not have the form (he or she should), get it directly from the carrier, which maintains all the policy forms it has ever used. Only by reading the policy can you determine what coverage actually exists.
It is generally imprudent to rely on the agent's description of the coverage. The agent is not a lawyer and cannot make an effective legal analysis of the rights existing under the policy. Some carriers issue a variety of forms at different times, and policy forms change over time and vary between companies, so an agent may have only a loose understanding of an obsolete policy form. The agent's only basis for knowing the insured's rights is what the insurance company says they are-and the company may be inaccurate or misleading. What the agent understands can turn out to be quite different from what the law will determine.
Recovering Lost-Rent Income
The non-earthquake provisions of Casualty or General Apartment Owner's policies may prove to be helpful. A loss of rents provision will allow the landlord to recover lost income. Exclusions for earthquake damage or loss from earth movement (for example, personal property damaged by an earthquake) might not include loss of rent, even when the renters' damage is clearly caused by the earthquake.
Even if the policy does not reimburse for lost rent, the loss of rents may affect the amount of money available for repairs. For example, a devastated building that would cost $1 million to repair is subject to a $100,000 deductible. The lost rents may be included in the money used to make up the deductible. If the insurance policy is All-Risk and covers loss caused by earthquakes, the lost rents are included within the covered loss, even though the maximum payment that the insurance company might make is for repair or replacement of the property.
Other Forms of Assistance
Federal assistance from either disaster relief or loans may pay the owner's deductible. Owners, however, must be wary in accepting assistance to compensate for the cost of repairing the property. Insurance policies contain subrogation clauses, which entitles insurance companies reimbursement for part of its losses to the extent the owner is able to recover the loss with an alternative source of money. The right of the insurer to subrogation is contained in the policy, but despite language in the policy, the insurer may not be able to recover any money from the insured until he or she has been made whole. This means that the insurance company may seek to receive some of the disaster relief granted to owners to reduce its own losses, but has no right to receive any until the owners have been paid for their loss in full.
Owners obtaining relief should conscientiously determine their losses from physical damage to a building, damage to any personal property that is used in operating the property, and lost rents. This will allow them to allocate disaster assistance to certain items and use available insurance payments to maximum effect.
Certain physical components of the building may have had latent defects that were only uncovered by the earthquake. In such cases, owners should determine if insurance other than Earthquake coverage will pay for property repairs. Insurance policies can pay for repairing many of a building's components. For example, pre-earthquake damage caused by faulty plumbing and electrical or mechanical systems may be covered. Many older buildings have asbestos in 'cottage cheese' ceilings or as part of the building's insulation; for these, special and separate repair measures may be covered by Liability policies.
Third-party liability provides a significant source of funds for repair. For example, damage may be the result of poor construction. Experts should determine whether the property had met codes and standards, including seismic safety standards. If the building was defectively constructed and the defects contributed to the earthquake damage, the builder or prior owner may be liable for the cost of repair.
It is important to take lots of photographs of the property's damage. Pictures of newly exposed beams and other normally hidden parts of the structure can be particularly valuable.
Ideally, a construction expert should inspect the nature of the damage. It's best that this expert be hired by the owner's attorney rather than the owner directly, even though the owner will pay for the services. This allows attorney-client privilege to cover the expert's report, lending greater flexibility to the owner's case. Even if this 'consulting' expert is not an expert in litigation, he or she will be able to provide the attorney with the factual basis for knowing if a claim exists and how that claim can best be proven.
The Mortgage Factor
Because the mortgage holder is named as an additional insured, any checks from the insurance company require the lender's endorsement. As a condition of the endorsement, a lender may require that a construction disbursement account be established and that all of the necessary funding (including the deductible) be deposited in the construction disbursement account to assure the lender that all of the necessary repairs will be made. The requirements imposed on a borrower to ensure completion of improvements are generally determined by the loan instrument.
Undoubtedly, some lenders who felt before the earthquake that their loan was 'underwater' (not equal to the value of the property used as security) will attempt to force the borrower to use the insurance payments for the loan rather than to restore the property. Under California law, the borrower must use the proceeds to repair the property or the lender will be entitled to apply them to the loan.
The fact that the property is being repaired does not excuse the owner/borrower from meeting mortgage payments. Thus the owner may have to default on the loan, giving the lender an excuse to take the insurance proceeds if no payment can be made. This is not always undesirable. As a result of the insurance payments, the owner may be able to pay off the loan and demolish the building-which could be more desirable than the owner's pre-quake condition, since the owner might then have some insurance money and own the land free and clear of debt.
When the value of the property before the earthquake was less than the loan, the borrower may find that bankruptcy provides an excellent opportunity to restructure the debt and regain some equity.
The rules of bankruptcy are complicated. However, a bankrupt borrower can, under the right circumstances, force the lender to reduce the loan to the value of the property and then pay interest on the loan at the reduced amount. When the property is rebuilt, the owner may have some equity because it will now be worth more than the reduced loan. Moreover, the property can be designated as cash flow as a result of lower debt.
For many people bankruptcy is not acceptable. On filing bankruptcy, all of an individual's assets become subject to control of the court. However, a partnership or real estate investment company with a limited number of properties in its asset and operational base may greatly benefit by filing a bankruptcy proceeding during this difficult time.
Many strategies exist for owners of apartments who want to salvage their hard-earned investment from the devastation of the Northridge earthquake. Owners need to understand all of the insurance policies available, the physical and structural causes of damage from the earthquake, and their rights as a borrower. Thorough and meticulous planning and investigation can enable the owner to realize value from an investment that seemed hopelessly lost after the January quake.