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Market Value vs. Replacement Cost

I couldn't count the amount of times this is questioned and for good reason. You see your tax valuations/market value and then see your replacement cost on your homeowners insurance. Usually, they are thousands of dollars apart. And there is a reason for that. Let's try and make the difference between the two make a little more sense.

Market Value and replacement costs of a building are not the same thing. In fact, they are distinctly different concepts and are estimated using different criteria.

Let's start with your market value or tax valuations on your home. This is determined by the city or town in which your home is located. An assessment takes into consideration the overall quality of the home, square footage, structural features, land value, housing market, etc. The municipality may send someone out to the home to physically inspect the property to make sure the information they have on file is correct. Market value also represents the agreement between buyer/seller of what that property is worth.

A common misconception about replacement cost is that it is in part determined by market value. This is not true. Market value takes into consideration land and location in establishing purchase price. Replacement cost does not. Replacement cost is the cost to construct or replace at a given time, an entire building of equal quality and utility, labor costs, material, overhead, etc. It will also include demolition, debris removal, any improvements to upgrade to current building codes, etc.

The replacement of the building uses modern materials and current methods - at today's values. What might have cost $100,000 10 - 15 years ago is going to be significantly higher to rebuild at today's costs. Another example: on a 1,000 square foot home in a metro area might sell for $350,000 but your replacement cost might be $250,000. But that same square footage home in a rural area might sell for $200,000 but still be replacement cost at $250,000. The cost to rebuild that home regardless of where does not change. (There are a few circumstances such as on a mountain vs city that could alter this.)

Economic conditions do affect both market value and replacement costs. Supply and demand for housing could impact the market value of your home. The supply and demand for labor and materials will affect the replacement cost of you home. When economic situations arise, like we are seeing currently, where supply does not equal demand, market value and replacement costs can change drastically and quickly. These things can be short term or temporary. These are constantly being monitored by both sides so rates can be adjusted.

So chances of you ever seeing your market value match your replacement costs are very slim to none. The factors included to come up with a value are just not the same. When your insurance agent is asking you a 1000 questions about improvements or updates, roofing age, etc about your dwelling, it is in order to determine an accurate replacement costs. Once we gather all the information we enter the data into what is called a replacement cost estimated or an RCE. Every insurance company uses these. The software then applies today's cost for labor and materials, debris removal, square footage, etc and gives us the replacement cost for your home.

Insurance is in place to put you back to where you were before a loss. If you lost your home in a fire and it had to be completely torn down, debris removed and rebuilt, chances are your market value is going to be quite a bit different than what it is going to cost to rebuild your home.

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