Disasters at income properties come in many forms. Over our years of practice, our clients have had fires, major wind damage, hurricane flooding, COVID, partner embezzlement, and even murder. When disaster strikes, you need a plan for dealing with your tenants and your investors.
Your property manager (if you have one) should be able to guide you on what to do with tenants. But what about your investors? It’s possible your insurance won’t cover all income losses, so you need to be prepared on what to do next to preserve their investment.
Here are some tips that we’ve learned from our clients and other professionals we’ve met over the years:
Hire a public adjuster for major insurance claims
Don’t try to negotiate your own settlement with the insurance company. Your insurance company’s job is to minimize your claim for the sake of their investors. Your job is to maximize the claim (or at least adequately cover it) to protect your investors from loss and to best serve the housing needs of your tenants. Hire a professional public adjuster that can help you accurately assess the damage and negotiate a fair and adequate settlement. They typically take their fees out of the settlement, so you shouldn’t have to pay upfront.
Immediately notify investors
Don’t let your investors hear about the damage to their investment on the news. Depending on how many investors you have, you may wish to call them versus sending an email. But either way, get the word out to them as soon as possible and let them know what happened and that you’re gathering information and will keep them up to date as soon as you know more.
Call an investor meeting within a week
Share with your investors what happened; how extensive the damage is; and what you are doing to protect their investment. If you normally have quarterly meetings, you may wish to start having them monthly, or even weekly, depending on your circumstances. If the property is at risk of causing investors a loss or ending up in foreclosure, step up your communications; listen to your investors; and keep them apprised every step of the way as to what you are doing on their behalf.
Your deal can go down in flames without an investor lawsuit if the investors believe you did everything in your power to salvage their investment. I know someone who lost a property because of a wind storm. The insurance company offered them $200,000 for a $2,000,000 loss. Because one building went completely offline, they weren’t able to make the mortgage payments and eventually lost the property to foreclosure and their investors lost money. Because this syndicator had weekly meetings with their investors – who knew that the losses were beyond the syndicator’s control, there were no investor lawsuits filed.
If you don’t communicate frequently enough, your investors won’t know about your efforts and may believe you are doing nothing. This is the stuff lawsuits are borne of.
No matter what, don’t stick your head in the sand and stop communicating with investors. I know someone whose partner stole money from investors and left him holding the bag (yes, this can happen – see our article about avoiding fraud in your syndicate). This syndicator’s criminal attorneys told the remaining partner (who had done nothing wrong) to close his office, shut off his phone, turn off his email and move out of his apartment. WRONG ANSWER! Investors went crazy and he’s forever going to be in hiding – who wants to live that way? If he had faced the investors and kept them apprised of what he was doing to help them, the situation could have had a much smoother outcome, and he may have still been able to show his face in public.
Make sure you have rental loss insurance
This insurance can cover your income losses if some or all of a rental property becomes temporarily uninhabitable as a result of a covered loss. This should give you time to rehab or rebuild. But make sure the coverage lasts long enough – rehab or reconstruction could take a couple of years and many policies only offer 12 months of coverage.
If you have uninhabitable units, you should tell your investors you are suspending distributions so you can accumulate reserves to cover any deficiencies in rental loss insurance versus actual losses, delays in getting insurance claims released, or possible construction cost overruns. It’s far more important that you have sufficient reserves to make the property whole and to cover lost income than it is to make distributions to investors at this time.
You can periodically show them the bank statements so they see the accumulated reserves, and assure them it’s their money if it’s not needed. But you don’t want to get into a situation where the property is lost to foreclosure because you didn’t have sufficient reserves – or you have to make a capital call to get them back.
If your syndicate offers a preferred return, assure your investors that the returns will still accrue and that the property will be in better condition, and worth more, when it’s completed, so there is little risk that their distributions will be permanently lost.
NOTE: This information is of a general, educational nature and may not be construed as legal advice pertaining to your specific offering, exemption or situation. Such advice must be sought from your own attorney, pursuant to an attorney-client relationship, after consideration of your specific facts or questions.