Replacement Cost vs. Market Value

In homeowners insurance there is a constant question between insured and carrier about the amount of insurance on a home.  Insurance carriers want to insure a home for its reconstruction cost, the actual price of materials and labor to rebuild the home.  The homeowner typically thinks of his home's value in terms of market value. And while there are certainly some commonalities between the two...they are separate concepts.  We'll explore the relationship between Replacement Cost vs. Market Value next...

Replacement Cost

Let's talk about replacement cost first because that's the language of insurance for most standard carriers. This number is calculated based on construction material, size, location and a number of other factors, including the individual touches in a home that all add up to the cost to rebuild from the foundation up.  It doesn't take into account the cost of the land, but it does include factors such as:

• Trends in material costs
• Fuel costs
• Labor costs and availability
• Changing construction codes
• New technology

 Most carriers use a software package that calculates all of these factors and spits out a number. An independent agent should be able to help you arrive at this number by going through the features of your home.

Market Value

On the other side of the coin is market value, which is basically the sale price of your home. This would include the house, the yard, the general location and a lot of other factors that real estate agents could come up with.  In the end, the market value is whatever someone else is willing to offer. It's less science and more art in some cases.  Since 2008 the real estate market has hit some historic lows with values plummeting from where they were in the early 2000's.  Factors in the market value of a home include:

• Sub-prime loan crisis
• Foreclosure rates
• New house starts
• Location factors
• Land Value

All of these have worked to push values lower to the point where it is not uncommon to have the replacement cost of a home be higher (and in some cases significantly) than the market value.  It may even be the rule right now.

In a future post we'll tackle the issue of rising replacement cost figures and examine both sides of the argument, but for now just know, you don't want to insure your home for the market value, because the market value isn't concerned with how much nails and counter tops cost (at least not directly).

If you have further questions please do not hesitate to give me a call.

Dan