How Added Value And Insurance Value Differ
It’s been said that a little knowledge is a dangerous thing. I’m not sure I subscribe to that theory holus-bolus. It surely depends on exactly what source of knowledge is being imparted.
Is it directions to a dry cleaner? Not so dangerous.
Could it be the password to the VIP area of an underground night club? A touch more dangerous perhaps.
Is it the nuclear launch code? Probably getting up there in the danger stakes.
However, when it comes to property dealings, I appreciate an inquisitive mind. Clients who ask questions can gain an understanding of what we do as quantity surveyors and how the world of property investment operates. Having a noggin filled with handy facts can help you navigate the bricks and mortar space with confidence and awareness.
It’s within this vein of sharing, that I want to lift the veil on a common misunderstanding we run across time and again. That’s the difference between added value, insurance value and construction cost.
Have you ever seen a valuation report a registered property valuer has prepared for a bank? If so, you’ve probably rushed past the array of wordy information and headed straight to the page with the all-important figure.
Now, this figure will often be shown as a breakdown between Land and Improvements. This calculation describes the added value each of these provide to the overall market value in the valuer’s professional opinion.
To simplify, say a property has a total assessed market value of $500,000 shown as follows:
In this instance, the valuer has determined the house, fencing, landscaping driveway and every other improvement contributes $200,000 of market value to the property.
Why is this important? Because, this figure is not a replacements cost, construction cost, insurance figure or any other element. It is simply how much more an average buyer is willing to pay over and above the land value for that given set of improvements.
As such, identical improvements can add different value to different properties depending primarily on location.
Say you own a home in a plush neighbourhood where everybody has plenty of cash and it’s full of beautiful homes with yards and pools. In this instance, most buyers will pay the premium for a pool. They expect one, after all! It’s part of the reason they love the area. They might pay, say, $30,000 extra for a house with a pool as opposed to one without.
Now, say you had the same pool in an area where everything was far more modest. Buyers are budget conscious and aren’t looking for added frills. A pool becomes just another item of upkeep. Cleaning, chlorinating, running the heater… who needs it! In this location, that exact same cool pool might only contribute a premium of $5,000 to the market value.
Because market value is tied to local market supply and demand drivers, the added value of improvements can vary mightily from one suburb to another.
Construction cost and insurance value
The construction cost and insurable value of an improvement, is entirely different to its market value/added value.
Insurance value determines the amount your improvements should be insured for to ensure that if the worst were to happen and your property were devastated, you could be placed back into the same property that was there before the tragic event without being out of pocket.
Insurance value is an all-encompassing figure and really requires a qualified expert to be accurately calculated.
Let’s say you have a home that’s burnt down. Assessing insurance value requires us to first determine the cost of reconstructing the improvement –and it’s an involved and complex process.
As quantity surveyors, we draw on an array of resources to detail all the materials, fittings, features, finishes, professional fees, labour cost and every other component it would take to replicate the home.
This figure reflects the total construction cost – but it’s still not the insurance value because other costs need to be allowed for as well.
When you’re replacing a home, you’ll need to allow for the demolition of the existing structures and removal of debris from site. In addition, cost escalations. Remember, you may not be back living in this property for some 24 months. So, you need to allow for the cost that it is going to be in many months’ time - these need to be covered by the insurance as well. These should all be factored in.
The danger in errors
Now you understand the differences, it becomes apparent why confusion can be costly.
First up, if you’re looking to purchase a property and are trying to determine market value by only adding construction cost to land value, you’re trekking along the wrong path. Market value is a function of supply and demand. You must use comparable sales evidence and seek the advice of a qualified valuer for an accurate assessment.
On the flip side, if you’re looking to insure your home and other improvements, relying on advice from any source other than a qualified quantity surveyor could be a path to compounding the disaster that took out your holding in the first place.
While valuers might provide insurance assessments under their instructions from financiers, this figure is often little more than them applying an estimated rate-per-square-metre-of-living-area amount to calculate a construction cost estimate, and them adding an arbitrary premium to cover the additional costs.
The figure can be even more inaccurate if you use one of those online calculators that pop up when you google the subject. I cannot stress enough how desperately wrong these can be, as they rely on averages and estimates that can’t possibly be captured via the owner’s best guesses and the click of a button.
The outcome of an inaccurate insurance assessment should be obvious.
At best, you are paying additional premiums to your insurance company to cover an outrageously high amount that you’ll never need to draw on.
At worst, you’ll be woefully underinsured and, after disaster strikes, you’ll find yourself having to cover the shortfall out of your own pocket.
There is only one profession with the skillset to get this important figure correct – that’s right, quantity surveyors.
Contact a suitably qualified quantity surveyor to ensure they can ensure you are covering the right figure when it comes to peace-of-mind insurance in the property space.