Valuing of an investment property can be difficult. Add in the idea of a different value for insurance and you have a complicated world.
Demystifying Insurance Valuation
Lessons from Goldilocks
The valuation of any asset can be tricky, and who better to understand that than an investor.
I once approached an owner of a property that I liked. I had heard through a mutual friend, that he was thinking of selling it and I approached him, hoping to close the deal before he put it on the market. The short of it is, I asked him what he wanted for it. His response illustrates the point I am trying to make. “Well…” he said. “I had it appraised, and as an owner occupied unit it is valued at $121,000. As a Rental Property, it is valued at $185,000.” Okay…truth is, he never did answer my question.
The “market” value of a home is in the eyes of the beholder, and thus the negotiation. Obviously we try to be objective by looking at comparables and the price per square foot. A home can be appraised, but even that can be subjective (funny how they often come out to the same price as what the seller was asking, right? But I digress). Then you have your finance gurus who talk about valuation models that seek to determine the return, and therefore the value. We hear things like “Cap Rate,” and “Discounted Cash Flow,” that are other ways investors valuate properties.
For insurance purposes we care about one thing and one thing only; indemnifying you. We care about what the replacement cost of the home is. What it is going to cost to get you back to where you started. For investors, this means we are going to get the asset back where it was, producing cash flow. Also, we don’t care how much the land cost. The land will still be there to build upon; we only care what it costs us to start installing the walls, roof, floor coverings, deck, etc. We are looking for the replacement cost.
How do you determine that? It could be through appraisal (minus the land value), or through another expert opinion (i.e. a contractor or real estate agent). It could be through a “Cost Estimator Tool” provided by your insurance agent, or a combination of all these sources. The key is to find an accurate valuation and insure the home for 100% of that amount. Not more and not less.
Why? For a couple of reasons:
So, when it comes to valuation, remember Goldilocks and the Three Bears. You don’t want too hot (over insuring the property). You don’t want too cold (underinsuring the property). You want 100% of just right (replacement cost). So do some homework, figure out what the home is worth and insure it just right!
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