The Building Valuation Paradox
Is your building properly valued and insured?
The best way to confirm that you’re properly insuring a building is to have your broker provide Insurance to Value reports. These reports help your broker leverage stronger terms for your program, like no coinsurance, but can also provide support when negotiating with lenders. Insurance to Value reports also ensure your organization is paying the right amount for coverage.
Whenever I hear building owners describe the value of a building, I always think of that Young Lady or Old woman illusion drawing. I can do the same illusion for a photo of any building in any town – except there are usually three separate images you can see:
- If the photo is being viewed by a seller: “This building is on the best street, in the best market, fully leased with lots of upgrades. It must be worth at least $15M.”
- Same building viewed by someone paying the taxes: “This old thing? Sections of the building are very old and some of the square footage is wrong. It can’t be more than $9M in value.”
- And yet the very same building viewed by someone setting an insurance limit: “Here’s what I bought it for and my lender wants to see this number, but I should probably get this as low as possible to save cost.”
What’s a building owner supposed to do when it comes to building valuation?
- Different places, different prices.
What you purchased the building for includes the land, income potential and market dynamics. An identical building built in Manhattan will be valued quite differently than a building located in Chillicothe, IL. When there are large discrepancies between what’s listed on the policy and the replacement cost, the sales price is usually the primary culprit.
- But the bank said…
We know you need that loan originator to be happy with what’s listed on your certificate for closing, but lenders (or lenders’ insurance departments) sometimes get confused about the purpose of insurance. We’ve seen lenders ask for values equal to the loan amount which is usually aligned with sale price or just the amount of the note. Anyone who knows about 65% LTV knows that the number may be wildly undervalued.
- Value it as low as possible. You’ll never need the insurance.
Umm, no. Most insurance underwriters deal with undervalued buildings not by arguing but by adding a valuation component called “coinsurance.” Coinsurance basically reduces the insurance recovery by the same margin that the valuation is off. This means if you have a partial loss, like a pipe burst, and your building is stated at 30% below the estimated replacement cost, the partial loss will be paid at 30% below what you need to fix the damage.
It’s okay to look at your building three different ways. Just make sure the focus is clear when you’re looking at what replacement cost to list on your property policy.
If you want to learn more about obtaining Insurance to Value reports, talk to a member of the ‘A’ Team.
- Property Valuations- Tricky But Worth the Treat
- Property Valuation: Cost Approach Method
- Property Valuations – Be in Control of Your Data
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