An apple, an orange and a flea market

Or why market value and replacement cost value are not the same!

Recently we heard from one of our customers that a homeowner expected their replacement cost to be about $200,000 lower than our estimator determined. At first, we were puzzled because the difference between the expected replacement cost and the actual replacement cost was such a substantial difference. Were the entries for that valuation incorrect? We looked at them and while we questioned a few that might result in a slight change in the replacement cost, plus or minus, none were substantial enough to be likely to reduce it by $200,000 or anything close to that amount.

“Market price and replacement cost are not the same values.”

So, we wondered why the homeowner thought the replacement cost was too high and why by this very specific amount? Our assumption was that the homeowner was comparing the replacement cost to the market value. We confirmed this by researching the local real estate market where we found that homes with similar sized living areas were about $200,000 less than our replacement cost estimate. It’s possible that the homeowners recently purchased this home so the market price was uppermost in their minds.

The two values—market value and the replacement cost—are not the same value. Comparing them is like comparing an apple and an orange. Apples and oranges are both fruit and they are both round, but otherwise they are different tastes, textures and uses. Market value and replacement cost are both values but the similarity ends there. While those in the insurance industry may understand this difference, homeowners often are not as familiar with the difference between them. Homeowners may also not have as much (or any) access to sources of accurate rebuilding costs.

The Apple: Replacement Cost is what it will cost to rebuild the home with materials of like or similar quality, in the shortest amount of time and with a builder who is basically building the home as a custom-built house. Since only one home is being built there are no economies of scale that help to reduce the expenses for the builder. That means an increased cost to the homeowner for rebuilding the home over similar homes that are built as part of a development.

The Orange: Market Value is the value that comparable homes are being sold for in that area or what a buyer is likely to pay to purchase a particular property. This is the value that many homeowners are familiar with since they likely know the sales prices of nearby homes. However, just because a home can be purchased for a specific price doesn’t mean that it can be rebuilt for that same cost.

For example, (“the flea market”) if you buy a junky antique watch at a flea market for $5.00 and it turns out to be a valuable antique watch worth $750.00, the replacement cost value is $750.00 but the market value WAS $5.00.

Since it’s unusual to hear that our values are too high or too low—and almost never by such a sizeable amount—when we do hear that from a customer we dig into the issue quickly. While we solved this mystery of why the homeowner thought the replacement cost was so high to our own satisfaction and that of the agent, we also hope that we provided information that satisfactorily explains the difference between these two values to the homeowner. In this example, the replacement cost was higher than market value, but the opposite may also occur, especially in highly desirable markets. Someone could pay a lot more for a property than it would cost to rebuild it. The key is to remember that what a person paid for an item is not an indicator of what it will cost to replace that item.

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