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In today’s economy, it seems like we are receiving more questions regarding replacement cost and market value of homes and what the differences are between these two values. There are many homes that are selling well below their calculated “replacement cost“. They would expect to insure their newly purchased $50,000 home for the purchase price, although the actual replacement cost may be much higher. Although the housing market is currently declining, construction costs are actually increasing. The following information will help to explain why this is the case.
Simply stated, market value is the current resale value of a home. There are factors that can affect market value which include:
- Foreclosure rates-How many homes in a particular area have gone through foreclosure in the past year. If there are a large number of foreclosed homes in a neighborhood this could potentially affect the market value of other homes in this same neighborhood.
- Number of new housing starts-How many new homes are being constructed in a particular area. If there are new residential developments being constructed in a particular area this may affect the market value of other homes located close by.
Location-Where a home is located (close to businesses, in a residential neighborhood, in a certain school district, etc.) also plays a factor in the market value of a home.
Market value could potentially be either lower or higher than the calculated replacement cost of a home based on these types of factors.
On the other hand, replacement cost is the cost to rebuild a home at the present time to its pre-loss condition. Some factors that may affect replacement cost include:
- Material costs-The cost of lumber, drywall, asphalt shingles, or other materials thhat are used to construct a home.
- Fuel/energy costs-The cost of fuel and energy costs have been fluctuating over the past year. Generally, gas prices are higher than in the past which can lead to increased costs to operate construction machinery (bulldozers, cranes, etc), increased transportation costs for lumber needed for the project, etc.
- Availability of skilled labor-Experienced contractors usually come with a higher price tag to perform residential construction than less experienced contractors. Many of the less experienced contractors are going out of business. As a result, there is less competition, which also means less competition when it comes to pricing for construction work to be performed.
- Changing construction codes/standards-Building codes and standards are constantly changing. To keep up with the latest changes contractors may be required to pay higher fees for licensing. They need to ensure that the residential construction they are building meets current construction codes and standards for the area they are doing the work.
- Demolition-Tearing down of buildings and other structures. Steps need to be taken before demolition can occur such as obtaining necessary permits, disconnecting utilities, developing site specific safety and work plans, etc.
- Debris removal-Removing debris such as scrap materials (lumber, shingles, drywall/wallboard, asbestos material if used on prior constructed homes, etc.). Special removal procedures may be needed.
- Demand surge-If there was a hurricane that damaged several homes throughout a particular area this would cause the demand for labor and materials to be high and supply low, which would in turn increase material prices. The effect of this increase would not only be felt locally, but internationally as well, since residential construction is a worldwide industry.
