This era of the “Great Recession” has been a challenging one. Dramatic economic conditions have affected both the U.S. real estate market and the residential construction industry.

As a homeowner, you may be perplexed by the gap between the current market value for your home and the replacement cost listed on your homeowner’s insurance policy.

National data collected over the past year indicates extreme financial decline, with property market values plunging up to 40 percent in some areas, permits for new construction down by 37 percent, and foreclosure rates spiking across the county. Ironically, the costs to rebuild and repair a home are not declining at this same rate. Overall construction costs actually increased approximately 1.3 percent nationwide from January 2009 to January 2010.

Market Value vs. Replacement Cost
Market value (the price at which your home may sell today) is not the same as replacement cost (the price to repair or rebuild your home if it is severely damaged). When rebuilding a home, contractors must work with and match existing materials, which requires skilled labor that costs more. The cost to rebuild is always higher than the initial cost to build. Market value includes factors such as the quality of the local school system and popularity of the neighborhood and, therefore, is not a good indicator of the proper amount of insurance coverage for your home. The estimated replacement cost for your home, however, is a significantly more reliable indicator of the appropriate coverage limit needed in the event of a major loss.

Factors that contribute to rising construction costs:

• Varied spikes in building material costs.
• Fluctuating energy costs.
• A 3 percent increase in skilled labor from 2009-2010.
• Increased demand for imported raw materials and building products.
• Anticipated rise in inflation for 2010.

Factors that can affect home replacement cost:

• Contractor Fees – typically 15-20 percent of the overall building cost and they could be more for larger homes.
• Architectural and Related Fees – also includes interior design, engineering and other related fees. These should be included in the home replacement cost and can add another 10-15 percent of the overall building cost.
• Environmental Factors – natural disasters such as floods contribute to shortages in building materials and overall cost increases.
• Green Construction – building “green” is gaining traction among consumers; these technologies have contributed to rising construction costs from 15-20 percent more than traditional costs.
• Rebuilding Custom and Historic Homes – these materials are more expensive and fewer craftsmen specialize in custom construction; plus greater demand has led to increased skilled labor costs.

Ways to help insure your home to value:

• Make sure your replacement cost appraisal is updated every 3-5 years.
• Maintain your policy’s annual inflation guard so your coverage is in line with construction cost increase.
• Report any significant home remodeling projects or upgrades and make any necessary coverage changes.