They would pay the amount of title insurance you purchased when you aquired the property. You can protect your investment by having a title search done and purchasing title insurance when you close on the property. Inform the title insurer at that time that you you will be investing a lot more money in the property to rehab it (or do new construction) and that you will need coverage for more than the purchase price, they can do it either by allowing you to purchase the larger amount up front or by giving you a commitment to issue the larger amount when you actually start spending money on the rehab. This is done by builders of new homes all the time.
I purchase an abandoned house for $50,000 from the penniless heir of the previous owner. The building requires a ‘gut’ rehab which costs $200,000. I act as the general contractor, which for a project of this size is worth $50,000. The project entails significant financial risk, which is valued at $55,000. The property, after rehab, has a market value of $500,000. Shortly after finishing the rehab I find that my title is not valid and court awards the property to a different heir of the previous owner. The title insurer sends me a tearful apology with a check for …
A) $50,000 (the amount I paid for the property).
B) $250,000 (the amount I paid for the property plus the cost of rehab).
C) $300,000 (the amount I paid for the property plus the cost of rehab plus the cost of my time).
D) $355,000 (the economic cost of the rehab: (C) + $55,000).
E) $500,000 (the market value of the property after rehab).
If the answer to question (1) is anything other than (E) is there a way to increase the policy limits to $500,000?
If the answer to question (2) is no should I proceed with the rehab?
The general answer is A. If you got insurance for 50K, then that is what they will pay out.
If you are doing major construction you would want to have an “escalator clause” in the policy. This means as the value goes up because of the improvements you are doing, that the amount of title insurance also increases.
Also, you would argue in a court of law that the heirs will be “unjustly enriched” by getting title to the property. The heirs may have good title to the 50K property that you originally purchased, but the 200K in improvements are yours. The improvements were not there when you bought the property, so they are yours. Of course going to court is trouble in itself most of the time.