Real estate investors typically procure a replacement cost appraisal, or reproduction cost appraisal, and evaluate a property’s location, and market value before investing in a particular property. In a steady up-and-coming location, new businesses are opening and new buildings are being made to meet the demands of the marketplace. Replacement cost appraisal and reproduction cost appraisal can offer drastically different results and owners, investors and insurers should know the difference and what appraisal approach to take.
What is Replacement Cost Appraisal and How its Done?
Suppose you have a low-rise apartment building in Toronto and a severe storm causes extensive damage to the roof and walls which cause further damage to the interior of the building. The replacement cost would be to replace the components with similar materials, using current construction practices with similar functions at the current market price. So, the repaired components would be replaced with masonry, glass and other readily available materials. The Replacement cost is typically measured in dollars.
Replacement cost appraisals are common in the insurance policy of homeowners in case of floods, earthquakes, storms, fires and other natural disasters.
Why Does it Matter?
Replacement cost matters most in commercial real estate investments because it keeps investors of old, and sometimes historic, commercial buildings on their toes. Investors of the old commercial buildings would have to keep investing money in the old building for renovation and better functions to keep up with investors of new buildings and the ever-changing demands of the marketplace.
As rent rates and location growth rates are changing rapidly, it is only logical that renters or buyers would prefer newer buildings with innovation to match the price or rent rates. When disaster strikes and the building needs to be rebuilt, replacement cost is typically the most cost-effective way to make the property owner whole again.
In the case of a historical building, or property of significant heritage value, the owner and perhaps the City may want to preserve and restore the historic features of the property and therefore a reproduction cost appraisal is what is required.
How to Calculate the Replacement Cost?
To simply put it, get an estimate from a local contractor or local insurance company to know how much it costs to construct a building per square foot, and then multiply that by the square footage of the building and the answer you get is replacement cost.
Sometimes replacement cost depends on an 80/20 rule. A single-family residence has to be insured up to 80% of a property’s replacement cost. If that’s not the case, they may not get the full value.
Insurance companies usually pay the replacement cost in two installations: first, they pay the depreciated cash value of the improvements; and then they pay for the replacement materials or objects you purchased in place of the original one.
Difference Between Replacement Cost and Market Value
Replacement value is the value you get in exchange for your damaged property if peril strikes or the cost an owner or investor would incur to replace the property and/or its improvements on site.
Market value is the price at which a property is expected to transact in a fair and reasonable exchange between buyer and seller in the open market. For example, if you sell your home at market value for $1 Million, the replacement cost could be only $700,000.
Market value is decided upon the square footage of the land, the building, the area in which it is situated, and if all essential amenities and luxury are available nearby.
Replacement cost is the estimate you would have to spend to build a similar building with similar materials and utility in today’s labor and material prices. It is advisable to let your insurance company know about any renovations you do to increase your replacement cost in order to protect yourself in the event of a disaster.
Difference Between Reproduction Cost and Replacement Cost
Reproduction cost appraisal is the estimate you would get to build a replica of the building using exact materials, architectural standards, quality of workmanship, and embodying all the deficiencies or historical elements of the building.
Conversely, a replacement cost appraisal is an estimate you get for building a similar building with the same purposes using modern building standards, design, labor, and better materials to meet the craftsmanship of modernity.
For example, if the wooden flooring gets destroyed by flood, you get the reproduction cost to redo the wooden flooring. With replacement cost, you can do vinyl or marble flooring.
Investors should always research the property’s location, new developments being made, ever-changing market prices of land, labor, material cost, as well as replacement cost appraisal and what risks it entails and how to avoid it. We do the hard work for you and help you make the right choices to get your money’s worth.
Nicro Realty Group is a leading real estate company helping investors to build strong economic assets and minimize risk for a better future through our years of expertise and knowledge of the commercial market.
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