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In a previous article, we looked at how rising demand for large homes is driving up the average value of newly built residential properties in the United States. However, for properties of all kinds, it is important to distinguish between the sales price—what a consumer pays to buy the property—and the replacement cost valuation—what it would cost to replace the structure. However, while the two are separate, there are certain factors that can affect both of them.

If there is strong demand for housing in an area with a limited inventory of available properties, the sales price of an average home will typically rise. However, if the imbalance between supply and demand leads to a surge of new construction and the region's contractors and building material suppliers end up stretched too thin, it can also drive up the cost of replacing existing structures. As replacement costs in an area increase, if insurance policies are not updated appropriately, property owners could be left with inadequate coverage.

Cities, suburbs and rural areas can all be affected by rapid development

There are many examples of this effect. Many major cities are seeing rapid growth today, and nearby suburbs are being pulled along in their wake. For example, Boston's downtown area is seeing extensive residential construction after being regarded as a solely commercial area for decades. An influx of interest from wealthy buyers is raising the market value of real estate, but may also affect the cost of replacing structures in the area, as the city's construction resources are increasingly devoted to planned development projects.

Values may be on the rise in nearby Somerville, Massachusetts, for the same reason. Once upon a time, the area was best known for being the home of Whitey Bulger's notorious Winter Hill Gang. Today, it is seen as an up-and-coming neighborhood, with rising property values and an attractive social and professional environment that is constantly being bolstered by new development.

At the same time, demand remains high in cities like New York and Los Angeles, which are established favorites of high-wealth buyers. However, a recent study performed by real estate brokerage Knight Frank looked at the home buying habits of "ultra-high-net-worth individuals"—those with more than $30 million in net assets—and found that they are spreading out again after consolidating their real estate investments in established cities in the aftermath of the recession. Many of the cities being targeted by these individuals are overseas, but domestic cities are also seeing growth.

Booming energy production driving up demand, values in Texas, North Dakota

In March, home sales hit a seven-year high in Austin, Texas, and demand seems set to continue rising. According to Austin Board of Realtors President Bill Evans, "the upcoming summer selling season could bring one of the most competitive markets Austin has seen." The National Association of Realtors has predicted that there will be an upward trend in home sales throughout most of the country this summer.

As a result of the surge in demand, the average price of a single family home in Austin has increased by more than 5 percent since last year. While this will not necessarily have an immediate impact on replacement costs, over time it could have an effect by causing an uptick in construction activity.

Taking a broader look at the state, a recent report from the Census Bureau found that four of the top ten fastest-growing U.S. cities—measured by the absolute change in population—are located in Texas. Strong job creation driven by rising oil and gas production and a relatively low cost of living have made the Lone Star State an attractive place to settle down, and the demand for housing near major metropolitan areas is especially strong. Houston is the fourth most populous city in the country, but it is growing much faster than third-ranked Chicago, and could overtake it in the coming year if current trends continue.

An oil boom is also behind skyrocketing demand for housing in parts of North Dakota. Unlike Texas, this sparsely populated state does not have a history of large-scale development and a robust construction sector. Furthermore, much of the available workforce is being drawn into the oil and gas industry, which leaves less labor available for residential construction work. This increases the potential for changes in demand to impact the cost of both new development and replacing insured structures.

Insuring to the appropriate value will remain challenging in booming real estate markets

Nationwide, the construction workforce is expanding, which may relieve some of the upward pressure on construction and replacement costs. According to the Associated General Contractors of America, employment in the sector hit a five-year high in April. However, there is concern about the industry's ability to continue attracting qualified workers. The approaching retirements of older skilled workers and a lack of interest among younger generations could lead to a worker shortage in the future. Also, regional disparities may persist, causing fluctuations in replacement costs between different locales.

Insurers may need to apply heightened scrutiny to properties in areas where high demand is driving a significant level of construction activity. Using the leading provider of web-based property valuation solutions can help companies ensure that properties are accurately valued and covered for the full replacement cost.