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Good Neighbors Insuring Commercial Space in Your Building

Many co-op and condo buildings rent out their ground-floor space to commercial tenants—retail shops, restaurants, grocery stores, doctor’s offices, and so forth. While the commercial/residential arrangement has many benefits on both sides of the equation, it’s a complex relationship that can be tricky to navigate, depending on the kind of building, the neighborhood, the type of commercial tenant, and a whole host of other variables. For instance, what kind of insurance does the commercial tenant need? What if their insurance lapses and damage occurs to the building? And, for that matter, what kinds of businesses make the best tenants?

Hello, Neighbor

If the commercial lease in your building is up and the tenant is leaving or renewing, or if your building is new and has commercial space awaiting tenants, Before renting out that vacant ground floor space, it’s best to examine the risks some types of commercial tenants might pose. Moira T. Imperial J.D., vice president of Accordia Inc., an insurance broker based in New York, says, “If you have a commercial occupancy, there are some commercial occupancies—such as restaurants, for example—that tend to increase premiums, because they pose the issue of cooking exposure and fumes. Businesses that use flammable materials and chemicals—such as dry cleaners, auto body shops and janitorial suppliers can increase your premiums as well.”

“The best business you could have as a commercial tenant would probably be some kind of professional offices,” says Jon Lipton, managing director of ARM of New York Inc., an insurance brokerage based in Manhattan. “With doctors, dentists, or the medical professions, you don’t have any cooking exposure or any other kinds of exposure.”

Lipton says the key issue for boards is to ensure that the commercial tenant has their own insurance and that they would indemnify the building owner in the event of a claim.  “If they have a professional liability exposure, you want to make sure that they have malpractice insurance, professional liability or errors and omissions [coverage].”

 According to Imperial, “The rate for commercial occupancy is different than the rate for an apartment building.” Apartment buildings, she explains, are rated on a per-unit charge, whereas commercial occupancy is rated per-thousand-square-feet of space rented.

Or, says Steve Principe, president of the Principe Agency, located in East Meadow, “[Commercial coverage] can be based on sales, or on the number of employees the business has.” And a company’s insurance rating can change over time, Principe continues. “Ratings are always changing—both improvements and claims can change a commercial tenant’s insurance standing. If the property value increases, you have to let your insurer know. By the same token, if your policy is based on the number of people you employ, and you make new hires, you have to let your insurer know that as well—because you’ll be paying more.”

Also, says Principe, your building’s commercial tenant or tenants can impact your relationship with lenders. If your building is looking to refinance, or take out a loan for major capital improvements, your lender may require certain proofs of insurance before going forward with the loan. “The mortgage company for the building can require that the tenant use certain insurers, based on rating. [The lender] can say they won’t accept a certificate of insurance if the commercial tenant is using a company that’s not A-rated. So in that respect, it could limit your options.”

Blue Plate Special

In many densely populated urban areas, having commercial tenants on the ground floors of otherwise residential buildings is unavoidable. In a city like New York that has literally thousands of restaurants—as well as thousands of residential buildings—the likelihood of shared space becomes even greater. As commercial tenants, restaurants pose a distinct set of insurance-related issues for their residential landlords.

“When there’s a restaurant present, the building gets specifically rated [by their insurer]—which means there’s a unique risk rating for that building in that location with a restaurant tenant,” Lipton explains.

The “unique risk” Lipton speaks of refers to the increased odds of fire in a commercial kitchen setting—along with other ancillary considerations such as chemicals and other health hazards, such as pests. While a conscientious restauranteur will do his or her best to minimize such issues, both parties’ insurers should do their part as well.

If a retail or restaurant tenant is found to be not-so-conscientious, says Imperial, any claim for damages incurred because of them would obviously be filed against their policy—unless their coverage is inadequate, in which case the difference would likely be made up under the building’s property insurance contract. “And,” says Imperial, “it would be paid under [the building’s] policy and the claim would be subrogated against the store that was guilty, because they didn’t properly maintain the premises or contain any hazard such as an open flame or a gas burner that caused the fire.”

The Cost of Coverage

Of course, everybody knows that the best defense is a good offence, so it’s To help minimize the impact of an accident or mishap, Lipton says insurance companies take pains to ensure that any tenant business has its own coverage in place, and that the building owner or sponsor is also insured.

“The company will also check to see if the tenant business has any subcontractors,” adds Lipton. “There might be some sort of separate agreement between that commercial tenant and their subcontractors.”

Lipton also points out that for most co-op and condo buildings, the cost of general liability coverage is typically worked out on a per-unit basis. When a commercial tenant is present, the cost is worked out based on the square footage that tenant occupies. Given that, many insurers may be hesitant—or may refuse outright—to write a general liability policy for a building with a restaurant that takes up a significant percentage of the building. In that case, Lipton explains, a building may have to default to a company that charges a much higher general liability rate than a standard or preferred company.

As for the tenant, a typical part of their general liability policy is something called “fire damage legal” which, according to Principe, “Is a policy where the landlord requires in the lease that the commercial tenant be responsible for certain structural parts of the building coverage. The tenant pays a portion of the building’s insurance cost, in other words.”

In the event of a fire caused by the tenant’s business for example, the building could pursue a fire damage legal payout, which Lipton says can typically range from $50,000 to $300,000. Once that limit is exhausted, the building can then go after the multi-million-dollar liability for property damage.

In the unlikely event that the tenant’s insurance lapses and a claim is filed in the interim, Lipton says, “The building’s policy would have to pick up the exposure and pay the claim. You could try to subrogate against a tenant that doesn’t have insurance, but the likelihood of collecting is virtually nil.”

The Manager/Tenant Relationship

So given the impact your commercial tenant’s business and behavior can have on your building, how involved should your board and manager really be in keeping tabs on your tenant’s insurance? Lipton says the building manager’s role in maintaining relations between building and tenant depends on the contract that the building has with the managing agent.

“Sometimes the managing agent will take care of everything, making sure that the place is kept clean, the sidewalks are clear from debris, there’s no general liability exposure in the space where they have flammables, and that they have their insurance in place—it really depends on the agent.” He says some of the larger buildings keep a close watch, while some of the smaller ones might tend to take a less involved role.

“The building manager is the one that the tenant would deal with, so the insurance specifications should be given from the building manager to the tenant,” Imperial adds. “The building manager has the right to look at the tenant’s premises on a regular basis and determine if anything has changed and created a hazard. If so, he can have it corrected.”

Reading the Fine Print

So how much coverage should a commercial tenant carry before taking a lease and moving into a residential building? The answer isn’t as straightforward as a simple dollar amount, say the pros.

“Most building owners have these standard boiler-plate policies requiring at least $1 million in liability, though a lot of times they ask for additional coverage—maybe a $4 million dollar umbrella,” says Lipton. “And they ask for a certain amount in fire damage legal, which typically would be between $50,000 and $300,000.” He says they generally also ask for $1 million in property damage coverage and require that the tenant name an additional insured. In some exceptional cases, they might even ask for a waiver of subrogation.

For his part, Principe agrees that between $1 million and $2 million in liability, with a $5 million umbrella policy is about right for most commercial tenant relationships.

According to some in the industry, a surprising number of building owners and/or boards fail to verify that their commercial tenants have adequate and up-to-date professional liability exposure in place. While some issues of liability may never directly impact the board or building itself, boards, sponsors, and management can take a certain amount of comfort from the fact that their tenant is looking out for his or her own liabilities and covering all the bases.

“The building should require that the tenant carry adequate insurance to cover their general liability, as well as improvements and betterments property insurance and rent insurance,” says Imperial. “The building should be named on that policy as an additional named insured and be held harmless by the tenant, so that the building cannot be sued for anything that the tenant did.”

While rare, it’s not unheard-of for a commercial tenant’s insurance coverage to lapse. Such an occurrence is worrisome enough in and of itself, but if there’s an accident or mishap during an uninsured period that does damage to the building as a whole, what was merely worrisome becomes very serious indeed.

“That’s why you want [your building] to be the additional named insured,” says Imperial, “because then the board or management would get notice of the tenant’s cancellation, and under your contract, you should have the right to buy insurance for them—with them paying the premiums, of course.”

A commercial tenant’s insurance requirements may vary depending on a number of factors, but regardless of how much both tenant and building have worked to minimize risk, the fact remains: some companies simply won’t write a commercial exposure policy in a residential building. That may make things a little more complicated and require more legwork on the part of the tenant, but it doesn’t make commercial coverage any less crucial.

So whether your tenant is a Duane Reade, a doctor’s office, or a bustling restaurant, by ensuring that they have the proper insurance and coverage your building can reap the financial rewards of having a commercial space without having to worry about the flambé bringing down the house.

Michael McDonough is a freelance writer living on Long Island.

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