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Market value and replacement cost: Not the same thing!

It’s alarming to see how the majority of property owners make the mistake of insuring their buildings for the purchase price or estimated market value.

In one remarkable case, we assessed the insurance value of a mansion in a remote rural location at R3 500 000, excluding its contents.

The owner was very unhappy with our valuation. The reason for his vehement disagreement with our valuation was that an estate agent recently estimated his property’s value to be around R1 500 0000. To him, this meant that our valuation would result in his property being grossly over-insured.

Replacement cost is not market value

This client – like many others – is confusing market value with replacement cost (which is the value used as the insured value).

A property’s replacement value cannot be determined by an estate agent. Only a qualified and experienced professional valuer can determine the value at which your property must be insured to ensure sufficient cover. It is important to remember that this value is estimated based on what it would cost to demolish and reconstruct the building in the case of total destruction, for example, in the case of a fire.

Market value is the cost at which a property will sell on the open market.

Why it is wrong to insure the market value of your home.

Under-insurance

Back to our case study: In addition to this location having grave security concerns, the building also was in a bad state of repair - both of which negatively affect the market value but not the replacement value.

In the event of total loss, we estimated that it would cost him around R3 500 000 to clear the site and re-build the mansion to its original state.

This meant that in reality, he was underinsured by almost 60% due to confusing market value with replacement cost

Unfortunately, we are often faced with similar scenarios and that many property owners are underinsured, often by 50% or more. This is why the subject of this blog is one of the most important facts that a property owner can arm themselves with. Without a clear understanding of the difference between these two definitions, the property owner will face a hard reality at claim stage – when the insurer will inevitably apply an average and the owner’s claims will not be paid out 100% - or in the case of total destruction, when the owner may lose their home due to being radically under-insured.

Another blog you may enjoy reading: Mirfin's checklist for insurance valuations.