There are different definitions of value. Market Value refers to the value of the property that is bought and sold in a competitive marketplace. The legal definition of “market value” is a price in which the seller, is willing but not compelled to sell, and would accept from a buyer, willing but not compelled to buy. Establishing an opinion of value known in the industry as market value is measured by a comparison of market prices of comparable properties in comparable neighborhoods with comparable amenities.
Insurable value refers to a value that reflects the replacement cost of the structures. This measurement reflects the destructibility of the buildings and structures by fire, storm, or vandalism, which can be protected by insurance. This form of value should be based on the cost to rebuild “like” construction, not the depreciated cost. The insurable value does not include the value of the land because the land will not be destroyed.
Part of an appraiser’s job is to segregate the improvements from the land property value and determine a replacement cost which includes outbuildings and appurtenances. This is what is used to determine the amount of insurance. The appraiser will apply a depreciation factor, and perhaps an economic obsolescence factor to come up with an overall value. Depreciation and economic obsolescence are not considered in insurable value.
The loan processor or underwriter will need to segregate the value of the land from the replacement building cost to come up with an insurable value. This is important because the land value component differs with geographic location and desirability. A structure with an ocean view, lake view, mountain view, city view, park view, or amenity-based frontage may result in a high premium for the land component. The property is assumed to possess the quality of being pleasant, attractive, and agreeable, which results in greater demand. But the structure replacement cost may be the same regardless of land value.
Also, the amount of insurance is not required to cover your loan. If your loan is greater than the replacement cost of the building, then most likely the land is greater as an allocated portion of the overall value. You will want to discuss the amount of insurance with the borrower an insurance agent/broker to determine what is correct.
Although liability insurance is not required, we recommend that the borrower have coverage for at least one million dollars. If the property is a commercial structure, such as a rental or leased fee retail this would be part of the policy. If the property is a residential structure, in most cases the liability portion of the coverage is in the form of an insurance rider referred to as an umbrella policy.
In a past article relating to the risk of employing 3rd party vendors, I discussed the importance of choosing extremely professional vendors for your entire loan transaction. Insurance brokers are one of the most valuable, their knowledge of various coverages and the overall insurance market place is paramount.
There are additional types of insurance coverage that will be required depending on property type and usage. Various coverages may be contained in the primary insurance policy, or by special endorsement.
A few questions will need to be answered:
- Who are the primary insured parties?
- Are there secondary or additional insured parties?
- Are there 3rd party insurance considerations such as insurance that property owners require tenants or lessee’s covering various losses and liabilities, that are not or should not be the responsibility of the property owner?
Additional types of insurance are needed to cover furniture, fixtures & equipment, loss of rents, business interruption, employee theft, loss of intellectual property, use of an employee or vendor vehicles not belonging to the insured party, workers’ compensation, and liability.
Using a lender loss payee endorsement referred to as 438 BFU form, and the understanding of the mortgage clauses contained within is important. Remember that the insured party in a mortgage clause will be the lender rather than the borrower.
Business and Private Money Finance Consultant
Cell (949) 533-8315
I intend this article for educational purposes only and is not a solicitation.