Market Value vs. Replacement Cost.
Understanding the Difference: Market Value vs. Replacement Cost
When looking to insure a multi-family property, many often think they should insure the building for the price they paid for it. This, however, doesn’t accurately take into consideration what would happen in the event of a property loss that required rebuilding at current prices. What someone “paid” for a building or what a building is “worth” on the open market, versus how much the building should be “insured” for on an insurance policy are not the same thing. It’s important, therefore, to understand the difference between market value and replacement cost when looking to properly protect your property.
Market value, also known as fair market value, is just what it sounds like: the value your property would be appraised at if you were to put it up for sale and subsequently what someone is willing to pay for it. This value is usually what owners and managers feel their property is worth. It is based on the building and other factors, such as supply and demand, location, area crime statistics, local real estate climate (recent sales in an area of similar properties) and the amount and quality of land on which your building is located. Because real estate values constantly fluctuate, this number is likely to change over time.
Replacement cost provides for indemnification of the actual physical structure and returning the building to the condition it was in prior to the loss from a covered peril. It’s what an insurer agrees to pay for the materials and labor needed, at an estimation of today’s cost, to repair or replace the structure with like kind and quality as it was before damage occurred.
Replacement cost is generally calculated using two main factors: the cost of building materials and the cost of reconstruction labor. These numbers are based on the building’s location, size, use, and quality at the time of damage.
You should insure your property to 100% of its replacement cost value.
Why Insurers Use Replacement Cost to Determine Property Coverage Amounts
If you insure a property for its market value, you are at risk of having insufficient coverage. For example, imagine you purchased your multi-family property for $1 million and take out a policy for the same amount. The replacement cost to rebuild the property after a loss, though, is $1.2 million. If a fire or other insured event destroys the property, the insurance settlement would be for $200,000 less than the actual replacement cost of the property. You either have to make up the difference or build a new, less expensive structure.
Or, let’s say a multi-family property in a depressed area has a market value of $750,000. The same exact property located in a more upscale area may have a market value of $1.2 million; however, the cost to rebuild the property after a loss would be the same in either location. You want to ensure that you will be paid to replace the property as it was before the loss, regardless of the location.
In addition to Replacement Cost coverage, having Ordinance or Law coverage included in your property policy is also important to cover the increased cost of rebuilding, repair or remodeling mandated by local, state and federal building codes.
Remember, market value is how much someone is willing to pay for a property, while replacement cost is how much an insurance company will need to pay to have a structure repaired or replaced based on current material and labor cost trends. The two values should not be expected to be the same because they are two different methods of valuing property. It’s important to review this carefully with your insurance broker.
|Covid-19 Safety Guidelines for Commercial Buildings||June 3, 2020||View|
|Covid-19 Safety Guidelines for Community Association||June 3, 2020||View|
|Covid-19 Safety Precautions/Recomendations for Hotels||June 3, 2020||View|