Understanding the Difference Between Market Value and Reinstatement Cost
Sinead Campbell from London Flats Insurance, provides an insight into the difference between market value and reinstatement cost when it comes to insurance.
There seems to be a lot of confusion between these two terms. We even hear them being used interchangeably- but they’re very different figures, used for very different purposes.
Although they both relate to the value of a property and both a vital in their accuracy, that’s where the similarity ends. As insurers, the difference is clear, but to those outside the industry, we’d like to explain.
What is “Market Value”?
Market value is the price that a property would likely sell for on the open market. It’s determined by various factors, including the property’s location, condition, size, and the demand for similar properties in the area.
This term is largely correctly understood- and for blocks of flats it also includes considerations around potential rental or leasehold income
Market value can fluctuate significantly throughout the year. Changes in the housing market, interest rates, or broader economic trends all play a part in either increasing or reducing the accurate market value.
When is Market Value Important?
Market value is relevant when buying or selling property.
It helps buyers, sellers, and investors understand the potential return on investment and the fair price for the property. Lenders also rely on market value to determine how much they are willing to lend on a property.
It’s also crucial for capital gains tax calculations and when determining the equity available in the property for refinancing purposes.
What is “Reinstatement Cost”?
Reinstatement cost, on the other hand, is the amount it would cost to physically rebuild the property if it were completely destroyed, such as in a fire or due to a natural disaster.
This calculation includes the cost of labour, materials, professional fees (like architects and surveyors), and compliance with current building regulations.
The reinstatement cost doesn’t include the land value, as the land remains intact even if the building is destroyed. It also excludes market-driven factors like location desirability or the potential income from renting the flats.
When is Reinstatement Cost Important?
An accurate reinstatement cost is critical when arranging buildings insurance. Insurance policies should cover the full reinstatement cost to ensure that, in the event of a total loss, there is sufficient coverage to rebuild the property.
If the reinstatement cost is underestimated, the property may be underinsured, leading to significant financial shortfalls if a claim is made.
Regularly updating the reinstatement cost is also essential, as construction costs and building regulations can change over time. Failing to do so can result in underinsurance or over insurance, both of which can be costly.
Key Differences Between Market Value and Reinstatement Cost
Purpose:
- Market Value – Used to estimate what the property would sell for on the open market.
- Reinstatement Cost – Used to ensure the building is adequately insured in case of total loss.
Components:
- Market Value – Includes factors like location, income potential, and market demand.
- Reinstatement Cost – Includes costs for labour, materials, and compliance with building regulations, but excludes land value.
Influences:
- Market Value – Market conditions, interest rates, and economic trends.
- Reinstatement Cost – Construction costs, materials, and current building regulations.
Why Understanding Both Is Important
Understanding the difference between market value and reinstatement cost is crucial because both values serve different needs in different contexts.
For instance, over insuring based on market value can lead to unnecessarily high premiums, while underinsuring due to reliance on market value rather than reinstatement cost can result in a shortfall in coverage.
For property owners and managers, ensuring that the reinstatement cost is accurate protects against potential financial losses in the event of a disaster. At the same time, knowing the market value helps in making informed decisions about buying, selling, or refinancing the property.
For more information, please contact a member of the London Flats Insurance team on 020 7993 3034.
