Insurable Value – “The cost of total replacement of destructible improvements to a property; may be based on replacement cost rather than market value”
When it comes to real estate appraisals, property valuation or land valuation is the process of valuing real property. The value usually sought is the property’s market value. Appraisals are needed, because real estate transactions occur less frequently than other valued and traded entities such as corporate stock. Every property differs greatly from the next, so a thorough and competent appraisal is needed to determine the value of every property. The report an appraisal provides is usually the basis for things such as mortgage loans, settling estates and divorces, tax matters, etc. The appraisal report can be used by both parties to set the sale price of the appraised property. A licensed or certified appraiser will conduct these reports. Appraisals are generally concerned with market value, and under USPAP guidelines, are also based on the highest and best use of the real property and reported on a standardized form.
There are several types of value sought by real estate appraisals, the most common being market value, value-in-use, investment value, liquidation value, and insurable value.
Market value is of paramount importance to both business and real estate communities. Each year, real estate investments and mortgage loans are based on opinions of market value. Market value tends to be the most commonly used type of value a real estate appraiser will use because it refers to a price that a seller can expect to receive from a buyer in an open and fair transaction. Both economic and legal definitions of market value have been derived refined; while USPAP doesn’t define market value, it does give a general concept.
The three traditional methods an appraiser will use for determining value are: sales comparison approach, the cost approach, and the sales approach. Each approach is interrelated, and requires gathering and analysis of data pertaining to the property being appraised. One or multiple approaches to value may be used depending on their applicability to the assignment, the nature of the property, the needs of the client, or the available data. ( Other useful appraisal tools include AVMs).
The appraiser must think about the “scope of work”, the type of value, the property itself, and the quality and quantity of data available for each approach. For instance, appraisals of properties typically purchased by investors may give greater weight to the income approach, while appraisals of a single family residential property a buyer is considering would rather compare price, thus they would use the sales comparison approach (market analysis approach) While the Cost Approach is most useful in determining insurable value, essentially the cost to construct a new structure or building. So the choice of valuation method can change depending upon the circumstances, even if the property being valued doesn’t change much.
Lenders are asking more and more questions relating to insurable value when ordering appraisals. Insurable value is the “The cost of total replacement of destructible improvements to a property; may be based on replacement cost rather than market value”. This means the replacement cost, or actual cash value of a building that standard insurance policies cover. Insurable value is less than the property’s appraised or market value because it excludes the value of the land where the building is located.
Typically, commercial banks want a determination of the commercial property’s insurable value as well as its fair market value; this pertains to the replacement cost of the improvements. Insurable value does not include the underlying land value, or site improvements, but is based on a construction cost estimate of your property and may possibly be required in order to insure proper insurance coverage for properties. Land value is not taken into consideration because land is generally considered indestructible in real estate appraisals.
More often than naught, lenders order insurable value with appraisals because they are concerned with how much they will recover on a property in the event of a catastrophe. Lenders use insurable value in combination with a mortgage to understand the potential loss for a property.
However, Appraisers’ confidence when it comes to insurable value seems split down the middle. If an appraiser does not feel competent on an assignment, they must turn it down. In recent blog posts, many appraisers state the following:
“We do these all the time with commercial properties”
“I did one insurable value appraisal years ago, first and last, (took forever) I do not feel qualified and would be hesitant to rely on formulas, albeit from an excellent source. To me this is a specialty removed from what most appraisers are trained to do but if any delve into it , could be an income source.”
“I wouldn’t recommend making assumptions about insurance exclusions unless you’ve actually read the subject client’s policy and have some understanding of what you’re reading”.
“Your E&O insurance may not cover your expansion in insurable value estimates”