12 August 2024 // Andres Dominguez III
When determining the true value of your rental property, Zillow’s Zestimate might come to mind. However, in insurance, the most crucial valuation is the Replacement Cost. This article will explore the significance of Replacement Cost and its implications for insurance. Before delving into Replacement Cost, we will first clarify two commonly used valuation methods.
1- Market Value
Market value is a valuation method that varies because it is determined by larger market forces. Macroeconomic influences such as local market conditions, supply and demand, interest rates, and inflation impact market value. Ultimately, market value is determined by what the market is willing to bear. Buyers decide how much the property is really worth based on what they are willing to pay to purchase the property. As a general rule, the more competitive the market, you might expect to see a higher market value of a property.
2- Appraised Value
The appraised value is an estimated value of a property at a specific point in time, determined by a licensed real estate appraiser. A formal appraisal is usually required when obtaining financing from a traditional lender. Appraisals are objective assessments that focus on factors that are difficult to change, such as the property’s location, total square footage, architectural style, basement condition, and number of bedrooms and bathrooms. The appraised value also takes into consideration the land on which the property sits. For example, a 2000-square-foot home in one neighborhood may appraise for more than a similar 2000-square-foot home on the other side of town. The appraised value is important because it can impact how much financing a lender will offer you and is a requirement for most lending institutions.
3- Replacement Cost
Replacement Cost is the estimated amount it will cost an insurance company to rebuild your property from scratch, excluding the cost or value of the land. This valuation method focuses on factors such as square footage, materials, bathrooms, kitchens, and finishes of the property. Most insurance carriers use company-specific software that takes these inputs to estimate the Replacement Cost.
It’s important to note that you should insure your home for at least 80%-90% of the Replacement Cost to avoid penalties. If you insure the property for less than the Replacement Cost, the insurance company can and will penalize you at the time of a claim. This is known as the Coinsurance Penalty. Different insurance companies have various ways of assessing this penalty, so it’s essential to consult with your agent to ensure that your current building limit satisfies the Coinsurance Requirement on your policy. You can also read our article HERE that goes in-depth on the topic of Coinsurance | How Does Coinsurance Work?
Conclusion
The three valuation methods each have their own significance based on the situation. As far as insurance is concerned, the Replacement Cost is of utmost importance. Ultimately, insurance companies will cover the expenses for materials, labor, and construction needed to reconstruct your property. Therefore, it is crucial to insure your property for the correct amount to prevent any penalties for underinsuring.
If all this insurance and valuation terminology is making you dizzy, please contact our team HERE. We would be happy to explain Replacement Cost in more detail and we can even provide you with a free Replacement Cost Report of your property for your reading pleasure.
About the Author:
Andres has been consulting Utah Rental Owners and Entrepreneurs for over 8 years. He is a graduate of Salt Lake Community College and the University of Utah, where he studied Marketing. He is driven by his mission to render the highest level of service, provide the best coverage available, and build meaningful relationships. When not serving his clients, Andres enjoys running marathons, practicing martial arts, and snowboarding.