We recently wrote about the difference between a home’s replacement cost¹ and its market value² in the An apple, an orange and a flea market article. Now we would like to discuss the replacement cost for newly-built homes. Is their replacement cost the same as the purchase price that the homeowner just paid to have the house built? Logically, you would think so, but that is rarely the case.
Even a newly-built home’s replacement cost will normally be higher right after it has been completed. There are many reasons for this, including economies of scale, time factors and site accessibility. The contractor who builds multiple homes in a development is working on a clean lot, purchases supplies in bulk and has a different cost structure than a contractor who works on the reconstruction of homes. Rebuilding a home means finding a capable builder that is available at the time the home needs to be rebuilt. Time factors include the time pressure to rebuild quickly and inflation since the original construction, both of which increase the costs.
“A newly-built home’s price is rarely the same as its replacement cost.”
Just because one contractor built the initial home for a specific amount, doesn’t mean that contractor—or any other—will rebuild it for that price, even right after it has been completed. Why? That contractor may not work on rebuilds at all. Costs may have risen since the homeowner signed the contract. So, the replacement cost must take into account a range of builder pricing.
Typically, the more customized a home is initially, the closer the new construction cost will be to reconstruction costs. This is due to the reverse of economies of scale, where the original custom home was built as a single unit, not part of a development. So, there were no economies of scale initially, which moderates one of the factors that increases the replacement cost over new construction costs.
Was the customer involved in the new construction in order to save on some costs? If the homeowner did any of the work themselves, from acting as the general contractor, to painting, to installing the stereo speaker system, etc., or if the homeowner called in any favors and had some work done at cost, these savings would not be included in the replacement cost.
Were there any incentives or discounts that reduced the purchase price? If a builder needs to move inventory he may add incentives to the price. The replacement cost does not include any discounts or incentives.
As many disasters over the last few years show, many homeowners are underinsured—their coverage is not enough to rebuild what they currently own. When disaster strikes, an underinsured home can add to the homeowner’s stress. It can mean higher out-of-pocket costs to repair or replace the home. It can affect the homeowners satisfaction with their agent and carrier. It’s vital to help ensure that your clients have correct replacement values for their homes.
Contact us about estimator tools for Mainstreet® homes, high-value homes, mobile manufactured and kit homes, condos and co-ops. We also offer commercial and farm & ranch estimators.
¹ 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.
² 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.