Friday, March 27, 2009

Market Value vs. Assessed Value vs. Replacement Cost...what do they all mean!

At least once a week one of our clients will come to us with a concern about the amount of insurance they have on their home or commercial building. Often it starts with a statement similar to this: "I just received our renewal policy; I could never sell the property for that much! I want you to reduce our coverage to the market value"; or this: "I just received our new tax assessment and it is much lower than what we are currently insuring our home for, shouldn't we lower our coverage?"

My first response is to discuss with the client different key values on a property. Part of that process is an overview of how an insurance company develops a Replacement Cost Value. The main goal is to be sure they have an understanding of how the property is valued.

The three most important values you will see placed on a property are as follows:

1) Market or Appraised Value- how much a given piece of property is worth to another buyer;

2) Assessment Value - the value placed on a property for municipal tax purposes;

3) Replacement Cost Value - the value placed on a piece of property by an insurance company for the purpose of coverage.

It is important to understand that as a general rule these values will not be the same.

Market Value(MV)
In its simplest terms MV is the price a willing seller will sell a given piece of property to a willing buyer in a standard arms length transaction. However, if you speak to a Realtor, Mortgage Broker or Property Manager, they will tell you that Market Value is a product of many factors including location, size, features, current market conditions, etc. In order to develop a good MV, an appraisal of the individual property is done. This is typically a full physical inspection of the property followed by a detailed study of all the other factors. Then a valuation is placed on the property. It should be noted that this is the most fluid of all the values on a given piece of property as the factors are almost always changing. The only time the factors from the actual cost of construction play into this number is when it is a new construction. The new construction costs are used as a basis to determine the worth of building relative to the anticipated sale price. Obviously the truest indicator of the MV of a piece of property or home is what it actually sells for.

Assessment Value(AV)
This value is often the most controversial of values a property is given since it is a basis on which an owner will be taxed. On its face, AV is purported to be tied to MV. However, it is more heavily influenced by economic and political forces due to the financial needs of the local municipality that sets the values. The AV is tied to more generic market conditions (i.e. similar properties that have sold in the area), not specific factors unique to an individual property. Another key issue is the data is usually a historical picture of the market based on information from the prior year. We know this can be dramatically different, both positively and negatively, then what the current conditions are. There may be times the AV will be the same as the MV, however typically it is only for about a year or two immediately following the sale of the property when a true value has been set.

Replacement Cost Value(RCV)
RCV is tied to the actual cost to replace a given piece of property with the same materials and in the same manner in which it currently exists without deducting for depreciation. It is driven by the cost of materials & labor in the area the property is located.

“But Jamie” my client says, “I just built my house and I know exactly how much it cost to construct it. Why is the insurance company coming back with a higher number?” At this point, I stress the word replacement. I remind them Replacement Cost is an insurance based value and there is also a factor that some loss (i.e. fire or wind damage) has occurred. Once a loss has occurred the clean up and debris removal of the damaged property must now be taken into consideration before any construction or rebuilding can begin. The property owner can expect approximately an additional 10%-25% of value added to the RCV for this contingency.

Each value is important and unique to each area. Interchanging one for another, especially for insurance purposes, would lead to negative financial consequences. The best solution is to work with your independent agent as your advocate, to establish a Replacement Cost Value which is reasonable and agreeable to all parties.


  1. So you're saying once you have bought a house you can expect its replacement cost to grow indefinately, as well as the insurance premium? When has the cost of building materials or labor deflated? Are there annual graphs that show this correlation?

  2. The inflation built into your policy is usually between 2 and 6% per year. Occasionally the value assigned to your house gets ahead of the actual reconstruction cost. You should review this value with your agent every 5 years or so. However, the older a house gets, the harder it may be to locate some materials used in its original construction, and the more specialty labor may be needed to replace the structure for like kind/quality. So sometimes the replacement cost greatly outstrips the market value.

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