Catch contractor insurance exclusions before closing, using the policy review that stopped a Los Angeles fourplex purchase on page 85.
A new building can pass a physical inspection yet raise serious insurance concerns. This deal shows why new construction multifamily due diligence must include the contractor’s actual policy.
The inspection produced 17 minor punch-list items. The insurance review uncovered two bigger concerns:
• A residential square-footage exclusion. The policy excluded properties totaling more than 5,000 square feet. Certificates of occupancy showed roughly 5,600 square feet across two buildings.
• A contractor insurance prior-work exclusion. A another policy excluded projects predating that policy, which the host assessed as excluding this already-built project.
The host requested written carrier confirmation. An intermediary replied that the carrier would not provide it. Based on the policy language and responses, the host concluded coverage was absent and canceled the purchase. That was the host’s assessment, not an independently confirmed carrier determination. The client recovered the full deposit.
🔎 How to verify contractor insurance coverage
• Request the complete policy, including exclusions and endorsements.
• Compare project size and use with the policy’s restrictions.
• Check policy dates and prior-work exclusions against the construction timeline.
• Request written carrier confirmation that addresses the specific project and disputed exclusion.
• Consider whether a judgment against the contractor would actually be collectible.
Certificate of insurance vs actual policy: a certificate shows stated limits, but it does not establish that this project or a future claim falls within coverage. Read the policy before treating insurance as a checked box.
🏗️ Does contractor insurance cover construction defects?
The key distinction is resulting damage versus repairing defective work itself. Faulty stucco can allow water to damage sheathing or interiors. That resulting damage may qualify for coverage, while replacing the defective stucco itself may not. Contractor liability insurance is not a construction warranty.
For investors and their CPA advisors, buying a new construction fourplex in Los Angeles requires more than a physical inspection. Verify whether the contractor’s coverage applies to the property before you close.
Contact Advise RE to discuss advisory support for your next Los Angeles acquisition. Subscribe for practical real estate due diligence.
Coverage depends on the actual policy, exclusions and facts of the claim.
Transcript
[00:00] This month, I killed a deal over one page, page 85. The seller built the property and his own insurance policy excluded his own building. And the answer I got to define whether or not that was true came on a Sunday, forty-seven minutes after my question. That was the answer. And I’m gonna show you how you can catch something like that.
[00:22] You can totally replicate the exact method that I did to discover this. So here’s the setup. My client is a professional who is looking to get engaged in real estate acquisition, specifically multifamily properties in the city of Los Angeles. But having no experience in it, he engaged us to not only act as his brokers, but also his real estate advisors. And in that capacity, what we do is not only do we search for the properties, but we perform all the due diligence, we do all the underwriting, and we basically lend all of our collective experience over the many years of real estate acquisitions and developments and dispositions that we’ve done to that client so that they don’t have to repeat the same stakes that we’ve made.
[01:05] So let’s talk about the property. Property was a brand new fourplex built in the city of Los Angeles, never occupied before, has one set of brand new fresh tenants for each unit, and the building looks like it’s in great shape. Of course, it’s a brand new property. We went out and did a physical inspection. We hired a qualified home inspector to come and take a look.
[01:26] We came up with a punch list of 17 items, minor stuff, you know, this needs to be moved. The floor is a little bit uneven here. The roof needs to be patched here and there. And we also requested a copy of the contractor’s insurance policy, not the evidence of the insurance, but the actual policy itself. Looking at the actual policy is honestly something that nobody ever does, and I’ll explain to you why and why absolutely, especially when you’re buying new multifamily or any new project in any city, you should be looking at insurance as one of the first things, not one of the last.
[02:01] So most people stop at the evidence of insurance. Evidence says, well, million dollars of coverage per incident, $2,000,000 in aggregate should be good enough. Let’s check the box saying insurance is there. However, after having a lot of recent experience with this particular area in terms of construction litigation, I look at the policy as well. And when I looked at it, page 85 specifically said, all residential properties that have a total square footage of over 5,000 square feet are excluded from this policy.
[02:31] Well, I quickly took a look at the math, looked at the certificates of occupancy, and the total worked out to be roughly 5,600 square feet between the two buildings. So the policy looks like on the face of it, it is specifically excluding this property that my client wants to buy. So what’s this policy really? It’s the contractor’s liability insurance. And essentially what it’s doing is protecting you as the contractor and you as the buyer, depending on which side you are, from potential construction defects down the road.
[03:01] And the way it works is this. Most people think that new construction is flawless. It’s like consumer electronics. You know, you’re buying a brand new computer, you have a warranty period. If you don’t like it, just send it back to the manufacturer and everything will work out just fine.
[03:16] Not the case with new construction. The thing about new construction is everything looks fine in year one and maybe in year two as well and year three. But years four and five are when the latent defects start to appear and that’s when issues that maybe were not properly addressed during construction period start to manifest themselves down the road. For example, the waterproofing was not properly done around the building, and there was very small amount of rain in years one, two, and three. But year four and five, there was a tremendous amount of rainfall that year, and you start to see cracks in the stucco exterior.
[03:51] Perhaps you start to see water intrusion come into the windows. You don’t discover this until four or five years later, and you can’t physically or visually look at it and say, that window looks fine. Everything clearly behind it is also fine because you’re not Superman. You don’t have x-ray vision. You’re not able to see these things until many years down the road when they start to become more apparent.
[04:11] The way the law works is you basically have a statute of limitations of four years after you’ve discovered the latent defect to raise a lawsuit and try to resolve it through some sort of legal means. And after ten years, after the certificate of occupancy, you have no ability to come in for any sort of construction defect litigation. That period is over. Statute of limitations is completely over. You gotta move on with your life.
[04:31] So to that end, weirdly enough, it’s gonna sound strange, but older buildings tend to be a little bit safer than brand new construction because the older buildings have been tested by time. If they’re still standing after twenty, thirty years, they probably are gonna stand for another thirty or forty more. Whereas the brand new ones, you don’t know. We haven’t seen a earthquake. We haven’t seen a lot of rains.
[04:51] We haven’t seen a lot of winds yet test this building’s actual capabilities and its methods of construction. So why do we need insurance? Why not just sue the contractor? Well, here’s the problem. The contractor’s behind an LLC or corporation, and the corporation holds a bunch of tools, and it also owns maybe a pickup truck.
[05:10] And your judgment is for $3,000,000 of damages. And so what do you do? You get to collect the truck and the tools, and then you get a shiny certificate saying congratulations, you have a judgment of $3,000,000 that you can’t collect on, and you’ll never be able to do so. That’s it. That’s what’s in the corporation.
[05:27] There’s nothing more for you to collect. You’ll be right. You’ll be justified, and you certainly have the judges on your side, but without the means to collect, the judgment is worthless. Not to mention, you know how much money it took you to get to get to that judgment? I mean, it’s gonna be deep into the 6 figures.
[05:42] Lawyers are not cheap. You’re gonna have to hire construction consultants as well. You probably have loss of rents. Your tenants are also angry at you because you got all sorts of problems. The whole thing is a huge financial loss, and it can be so bad that quite honestly, if the damages are big enough, it might bankrupt you.
[05:58] If you just don’t have the wherewithal or the means from your own pocket to be able to fix these problems. That’s why insurance exists. Let’s do a side note here on what’s going on with construction defects and what insurance covers as well. This is a huge, huge misunderstanding, I would say, out there in the world that if you have a problem with your building and there’s a construction defect, that the insurance will cover that defect. For example, let’s say the stucco system was improperly installed around the building and as a result, the stucco starts to crack and water starts to intrude to the building causing the lumber behind the stucco system to be starts to degrade.
[06:37] It starts to rot away. And you’re thinking, great. I’ll step in, sue the insurance company, and I’ll get a judgment or I’ll get a settlement from the insurance company to replace the stucco system. Unfortunately, that’s not what’s gonna be covered either. Insurance only covers something called resultant damages.
[06:55] So what the essential theory around that is is let’s say the stucco system is bad, they’re only gonna pay on what the bad stucco system caused to other parts of the building. So if this cracks and it causes the plywood, for example, behind it to rot away, then they’ll pay to repair the plywood. If it causes mold intrusion, if it causes all sorts of other damage to the interior of the building like the flooring or the cabinetry or the insulation, they’ll pay to replace that. But what they won’t do, and I know this doesn’t make sense on the face of it, what they will not do is pay for the cost to repair the stucco system. Why?
[07:32] Because they claim that they’re not a warranty company. That’s not their role or responsibility. They’re only here to cover what bad work caused down the line. So a very expensive repair can actually still only result in a small amount of insurance damages because the resultant damages might not be that great. You might have caught it early enough where you know you have to replace the stucco system, but there wasn’t a lot of damage the interior.
[07:57] The drywall’s fine. It didn’t get through. The insulation’s still intact. And, you know, plywood sheathing is not that expensive to repair, to be honest with you. So you’re talking about thousands of dollars, whereas the exterior might cost you 1 or $200,000 to repair.
[08:11] That’s a huge problem to have, and it’s one thing that I want you to be very clear on whenever you’re thinking that your recourse is, I’m just gonna sue them. Oh, boy. You’ve already lost when you’re thinking that route. Okay? You know, know, it’s not like you push a button and then all of a sudden, congratulations, you now have sued the the contractor and then they’ve tendered the claim to insurance and now you’ve got a lawsuit against them too.
[08:33] You’ve got attorneys cutting away at 500 to $1,000 an hour. You’ve got construction consultants charging the same, and none of this stuff takes a short amount of time. It’s usually at least a couple years, and it’s a lot of heartache, and it’s a lot of it’s just a lot of mental damage. You’d rather go out there and look at new properties rather than trying to revisit the past. So there’s also mental toll in all this.
[08:53] And so I I see this word a lot. I’m gonna sue you. I’m gonna sue you. Gonna sue you. I gotta tell you right now, if that’s your primary strategy in getting around this, you’re you’re gonna be in really bad shape.
[09:03] But the very minimum, if you have to sue somebody, make sure there’s insurance in place because the LLC protection is going to essentially block your judgment if you get one, and the only company that’s out there willing to pay or write a check is going to be the insurance company. So let’s go back to the deal. Now I’ve given you a proper education on insurance. I requested a clarification on this page 85 exclusion. I get an answer back saying, no.
[09:28] No. No. Our wholesalers who helped broker the deal said that it only applies to custom homes. Okay. I I hope that’s the case.
[09:37] That sounds wonderful. Could I get something from the carrier in writing stating that? Because the policy doesn’t say anything about a custom home or one structure over 5,000 square feet. They simply say total square footage for residential use. That seems to apply very clearly to a multifamily project.
[09:55] They come back to me insisting, no, it’s fine. You should take our word for it. There’s no way we can lie anyway. So go ahead. You have this email here as your proof.
[10:05] We all we all know that that’s not gonna be sufficient. You’re not gonna be able to take that email into any sort of court case or tender to any sort of insurance company and say, see, a guy who wasn’t part of your company said that this is what it covered, and so we’d like you to, to cover our claim. They won’t pay attention to it. Then they come back and say, alright. Here’s another insurance policy.
[10:27] This one covers it. Again, scan through the documents. The evidence of insurance is never enough. And sure enough, on one of the last pages, says all projects before the date that they just got this policy are excluded. Our project happens to fall into that realm as well.
[10:42] Again, I raised another issue. Not accusing them of anything, but just simply saying, it seems like it’s excluding our property as well. What’s going on here? At this point, they start to get defensive and they start asking me, oh, is your client planning to sue us and all that sort of stuff. At this point, I have a very strong indication that there is no coverage.
[10:59] The fact that they had it but needed a new policy to prove it was a strong indication. And the final nail in the coffin was when I requested an email, clarification on what the policy really entailed on Sunday night and if they could truly just get a letter from their carrier stating that it confirms their position. I got an answer forty seven minutes late on Sunday night saying carrier won’t do that. And that was my answer. They didn’t have coverage and all there was was downside from going into this transaction, and I killed the deal.
[11:29] Also killed my commission, but, hey, at the very minimum, what ended up happening was our client was protected. He didn’t get into a situation that down the years, if there is a problem, God forbid, there might not be. But if there is, he’s gonna sit here and kick himself going, gosh, why didn’t Stefan just capture that when when we were looking at this deal back then? So the end of the story was we paid a small amount of money for an inspector to come out and look at the property. We reviewed some documents.
[11:54] Client got back all of his deposit, and he’s ready to move on to the next deal having been just a little bit wiser. For you, what you can look at is, especially on new construction, not only you’re gonna look at the way the property looks physically, which is nice, you should keep doing that, but you should always be asking for the contractor’s insurance policy, not just evidence of insurance. You need to verify coverage and you need to verify that your property that you’re trying to buy is actually covered under his or her insurance policy. If so, then at least you have adequate protection, not absolute protection. There is no such thing.
[12:26] There is this is the world of real estate. You’re gonna have to take risks. But at least you have some modicum of protection that down the road, you do have a target that you can go after in a lawsuit, albeit very painful lawsuit, and there is somebody on the other end willing to write a check. I hope this helps a lot. And if this is something that you’re interested in or if you’re looking to engage a real estate advisory firm to help you out with your next purchase, especially in the city of Los Angeles, then you can reach out to us down here, and we look forward to seeing you in our next video.
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