Let’s face it: Property insurance can be confusing! Even professionals who work in insurance full-time come up with questions from time to time.
One of the most confusing aspects of property insurance, in particular, is how market value and replacement cost differ.
Market Value Vs. Replacement Cost: What’s the Difference?
First thing’s first: Market value and replacement cost are not the same things. The only thing that they have in common is that they are both valuations (price estimates) of a given property. As a result, it is almost certain that both amounts will be different. And aside from that, remember that they are distinctly different in almost every other way as well.
Market Value Defined
This valuation is rather easy to discern. The market value is basically how much a property is worth. If you were to sell the property on the open market, and both a willing seller and a willing buyer participated in its sale, what would be the fair sale price for the property be?
Replacement Cost Defined
Replacement cost is not what a property is worth on the open market. Rather, it is an estimation of how much it would cost to rebuild a property completely and identically. This would include how much it would be to purchase all of the same (or comparable) building materials, how much the labor would be, and all other costs associated with replacing the property.
The “new property” (replacement property) would have to have equal utility to the old property. Furthermore, all associated replacement costs would have to be evaluated based on current prices (not the prices paid when the property was first constructed).
Factors That Influence Property Valuations
Of the two — market value and replacement cost — market value is usually easier to calculate. For the most part, the market value of a property can be determined by an appraiser or by regarding the original purchase price paid for the property and accounting for inflation over the years since the purchase.
Other factors may also influence market value. For example, it’s possible that the original property was purchased 50+ years ago. In that time, the property may have devolved greatly in quality and upkeep. It’s also possible that the land involved in the purchase has either become more or less valuable. Perhaps the property used to be in a well-esteemed school district, but today, the area is losing residents. All of these issues will factor into the market value of a property.
How Much Should You Insure a Property For?
Unless you are in the midst of selling your home, replacement cost is the real amount you need to determine in order to purchase adequate Coverage A (the amount a property is insured for). That is, you must know the replacement cost of a property so that you can adequately insure it for the amount it would truly cost to replace.
Here are some things to consider:
- First, the replacement cost of a property should not include the cost of the lot because this is not a portion that would need to be replaced after a loss (a fire or tornado, for example).
- Second, as with market value, the location should be factored into the valuation as well.
- Remember to evaluate replacement costs based on the current cost of equal-quality materials.
- Remember that material and labor costs can vary greatly over time.
Using our Replacement Cost Estimators, agents at Binford Insurance in Indianapolis can help you come up with the perfect amount of coverage you need for your property.
Contact us today to speak with an agent about your property insurance policy.