Market Value and Replacement Cost describes different types of commercial property insurance policies and their costs and coverage amounts. There are several factors that determine a property's market value, including location and real estate market conditions. Replacement cost policies provide funds to fully repair or rebuild a property without deductions for depreciation, but have higher premiums. Actual cash value policies provide lower premiums but deduct depreciation costs. Functional replacement cost offers even lower premium savings by using less expensive replacement materials. The best policy depends on a property's specific risks and financial needs.

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Market Value and
Replacement Cost
If you own commercial property, choosinga property
insurancepolicy thatfits your specific needs is important.
A wide variety of policy options areavailableatdifferent
prices that cover an assortment of reimbursement
options.Although there are policies thatoffer a large
amount of financial coverage,depending on the type of
property that will beinsured,it may make more financial
sense to pick a policy that still offers adequatecoverage
whilehavinglower premiums.
Commercial properties can be covered in a variety of
ways, and a number of factors can determine whether
your property’s valuegoes up or down each year.
Knowing how much your property is worth and obtaining
the insurancepolicy thatboth protects you and suits
your financial needs is important.The followingare
descriptions of common types of policiesand valuation,
and the costs thatthey generally cover.
Market Value
Simply put, market valuedescribes the estimated
amount that a property would sell for on the date of
valuation.Any land included in a commercial property is
also a partof its market value. The term market value
can be used interchangeably with open market value,fair
market valueor fair value.
A number of factors areconsidered when a property’s
market valueis appraised,some of which cannot be
influenced by the buyer, seller or appraiser.These
includethe location of the property, capitalization rates,
rent growth rate, the general state of the real estate
market and more.
Market valueis mostoften used when buyingor sellinga
property. However, it may also beexamined when
determining the type of insurancepolicy to placeon a
property, or the amount of compensation in the caseof a
loss.
Replacement Cost
Replacement or reconstruction costis a type of insurance
that covers the costto replaceor repair a buildingwith
materials of the same or comparablequality.For the
purposes of coverage—and unlikemarket value—
replacement costpolicies do not includethe valueof any
land and is determined based on the amount needed to
hirecontractors and purchasematerials to repair a
buildingor constructa replacement.
Theoretically,the replacement cost of a commercial
property should be lower than its market value,as the
replacement costonly has to take buildingmaterialsand
labor into consideration when determining
compensation. However, the costs of materials and labor
can fluctuate. This,alongwith the numerous factors that
contribute to market value, makes itpossiblefor the
replacement costof a property to be higher than its
market value.
A replacement costpolicy offers a largeamount of
financial protection in the caseof a loss,as itdoes not
take depreciation into accountwhen determining

2. Market Value and Replacement Cost
compensation. However, itis usually moreexpensive
than other types of coverage and,as a result, may not
make sensefor every property. Without continuous
maintenance and renovations to a property, the valueof
a buildingwill generally depreciateover time. However,
the cost of materials and labor to replacea lostproperty
is generally more fixed. Because of this,it may be better
to opt for a less expensiveplan that still protects the
operations of your business.
Actual Cash Value
Actual cash valuepoliciesfunction in a similarway to
replacement costin that itcovers the costto replaceor
repair a property. However, under an actual cash value
policy there is a deduction in compensation to account
for the depreciated valueof the original property.
A property covered under an actual cash valuepolicy will
be rebuiltor repaired usingmodern construction
techniques and materials.The difference between this
costand the depreciated valueof the original property is
only covered under a replacement cost policy and not
actual cash value.
Actual cash valuepoliciesgenerally havelower premiums
than replacement costplans,and they may make more
sense for particular types of properties. For example, a
store located in a very old buildingin a popular urban
environment will notdepreciate as quickly as a new
office buildinglocated in a business park.The store is
more location-sensitiveand does not require a specific
type of buildingto operate, so an actual cash valuepolicy
and its lower premiums may make more financial sense
than a replacement costplan.
Functional Replacement Cost
Another less expensiveoption for property coverage is
functional replacement cost.This type of policy is used
when a functionally equivalentbuildingcan befound to
replacethe original property ata lower cost than
buildinga replacement. A building’s functional
replacement costis lower than the replacement cost,
which results in a reduction in the amount of coverage
and correspondingly smaller premiums.
Functional replacement costcoverage can also be used
to repair a partially damaged property with less
expensive materials,such as replacinga wall with drywall
instead of plaster.
The main reason for usingfunctional replacementcost
coverage would be to savemoney with lower premiums,
so it may be a good option for properties that use
expensive materials thatare not necessary to the
function of the property or for buildingswith intangible
valuethat is not relevant to their commercial function.
Which Type of Coverage Best Fits Your Needs?
The valueof any piece of commercial property changes
constantly.Knowing your property’s value and obtaining
the policy thatbest suits your needs will safeguard your
current and future assets.Contact The Evans Agency, LLC
today to appraiseyour property’s valueand learn more
about which type of policy is bestfor you.