Replacement Cost – And Why Insurance Companies Don’t Care About Market Value

A commercial property’s replacement value is determined using several factors, including: square footage, construction type, and occupancy. Basically, what the insurance company wants to know is this a three-story building that’s completely finished inside, or is this an unfinished metal warehouse? These things make a huge difference when it comes to valuing a building.

What few people realize is that the replacement cost has nothing to do with the market value of the property. What the insurance companies are concerned with is the actual cost to rebuild a structure. They couldn’t care less what it would sell for or what part of town it’s in; that makes no difference at all to them. They care about how much it would cost to rebuild a structure from the ground up should something happen to it.

Actual Cash Value – And How It Differs from Replacement Cost

While replacement cost is the amount of money it would take to completely rebuild a structure exactly how it was before it went down, meaning the same like, kind and quality, actual cash value is going to be your replacement cost minus depreciation.

Some people prefer to value their commercial property this way for the simple fact that if their building went down, they wouldn’t rebuild. This may be because they’re nearing their retirement and wouldn’t continue running their business, or maybe the building would be nearly impossible or too expensive to rebuild the structure the way it stands today, such as a historic building.

Functional Replacement Cost – And Why It’s Hard to Get

For some of the same reasons some commercial property owners decide to go with actual cash value, others decide to value the property using functional replacement cost. This means that if the building went down, the owner would not want to rebuild it in the same like, kind and quality.

Commercial Property: Which Valuation Is Better?

While the rates are the same with replacement cost and actual cash value, the difference is the building value, so there are pros and cons with each. Under replacement cost, if your building goes down, the insurance company is going to replace it with the same like, kind and quality. Of course, at the same time, you’ll have to carry more insurance, making your premium higher. The pro of actual cash value is if you wouldn’t want to rebuild, you haven’t paid all that premium, but the con is, any claims are going to be depreciated.

Ultimately, the best way to value your commercial property depends on what you would want to do if something happened. As long as you build your commercial property insurance policy based on your own individual needs, you’ll be more likely to be in a better place if something were to happen.


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The views expressed in this article are those of the original source for this article. Any views expressed may or may not align with our own commercial property valuation insight.