The Everhold blog
Market value or replacement cost: which number should your rental be insured for?
Insure your rental for its replacement cost (what it would cost to rebuild), not its market value (what it would sell for). Put that rebuild number in your dwelling limit, the cap on what the policy will pay to repair or rebuild the building, shown on your declarations page, the summary page at the front of your policy. Market value includes the land and the location, which a fire or a windstorm can't take from you, so it can sit far above or far below the cost of putting the building back.
What's the difference between market value and replacement cost?
Market value is what a buyer would pay for the property today. It bundles the building with the lot, the neighborhood, and whatever the market is doing that month.
Replacement cost is what it would cost to rebuild the structure at today's labor and material prices, with materials of like kind and quality, meaning similar materials, not upgrades. It leaves out the land, because the land is still there after a loss.
Your purchase price, an online home value estimate, and the full cash value on your county property tax notice all describe market value in some form. None of them is a rebuild estimate.
Why market value is the wrong limit
On the declarations page, the dwelling limit is often listed as Coverage A. On a policy that pays replacement cost, a covered claim usually pays what the repair actually costs, minus your deductible (the part of each claim you pay yourself), up to that limit. The policy won't pay the full limit just because you chose a high one.
So when market value runs higher than the rebuild cost, insuring for market value usually means paying premium, the price of the policy, for coverage a claim would likely never reach. That's common where the lot is a large share of the price.
When market value runs lower than the rebuild cost, the risk flips. An older Arizona rental with solid block walls, a tile roof, or details no one builds anymore can cost more to rebuild than it would sell for. Insure that property for market value and a total loss could leave you short, paying the difference yourself.
A made up example
Say you own a rental that would sell for $420,000, and a replacement cost estimate puts the rebuild at $310,000. The rest of the price is the lot and the location. Insure it for $420,000 and about $110,000 of that limit would likely sit unused, even after a total loss. Now picture a second rental that would sell for $260,000 but would cost $300,000 to rebuild. Insure that one for $260,000 and a total loss leaves a $40,000 gap. These numbers are invented for the example; the pattern is the point.
Replacement cost means two things on a policy
The phrase has two meanings, and it helps to keep them apart. First, it's the rebuild estimate used to set your dwelling limit. Second, it's a way of paying claims: replacement cost settlement pays to repair with new materials, while actual cash value pays that cost minus depreciation for age and wear. Some policies pay roof claims at actual cash value, or on a schedule based on the roof's age, even when the rest of the building gets replacement cost. Our page on replacement cost vs actual cash value shows how each one pays.
You want the two meanings to line up. A limit at the full rebuild cost helps less if the policy settles claims at actual cash value, and replacement cost settlement helps less if the limit is too low. Many policies also pay replacement cost in full only when your limit is at least a set share of the full rebuild cost, so a low limit can shrink even a small claim. The loss settlement section of your policy, which explains how claims are paid, spells out the rule.
How to find your rental's rebuild cost
A rebuild estimate starts with the facts of the building: square footage, number of stories, construction type, roof type, garage, interior finishes, and the year it was built. Your agent or the carrier (the insurance company) runs them through an estimating tool that uses local building costs.
Include work done since you bought, like a remodeled kitchen or an added bedroom. Detached structures, such as a block fence or a shed, usually fall under a separate limit for other structures, so check that one too. If you rent out a casita on its own, to a tenant or to short term guests, ask how it's covered, since some policies leave it out.
If a damaged rental must be rebuilt to current building code, the extra cost may need its own coverage, often called ordinance or law coverage. Ask whether your policy includes it, and for how much.
What if your lender wants a higher limit?
If the rental has a mortgage, the lender sets its own minimum coverage, often tied to the loan amount or the replacement cost. If it asks for a limit above the rebuild estimate, your agent can send the lender the estimate and ask whether it will accept that number. Lenders often do, but each one sets its own rules, so get the answer before you close on a purchase or lower a limit.
How often should you update the rebuild number?
Rebuild costs move as labor and material prices change, so a limit that was right when you bought can drift. Some policies include an inflation guard that raises the limit a little each year. Some carriers offer extended replacement cost, which adds a cushion above the limit if a rebuild costs more than expected. Ask whether your rental policy has either one, and revisit the estimate at each renewal and after major work.
If the rental used to be your home
A homeowners policy is written for a home you live in, and a landlord policy works differently on the building, lost rent, and liability (claims that you caused someone an injury or damaged their property). If you moved out and now rent the home, check which one you have. For the home you live in now, the same rebuild question applies, and the Home Coverage Checkup page lists what to compare.
What to check this week
- Write down the dwelling limit from each rental's declarations page.
- Get a current replacement cost estimate for each property, not a sale price, a tax value, or an online home value estimate.
- Flag any rental where the limit is well above or well below the estimate. Before lowering one, ask your agent what else is tied to it, like other structures and lost rent coverage, and what your lender requires.
- Check how each policy settles claims, replacement cost or actual cash value, including the roof.
- Ask whether each policy has extended replacement cost, an inflation guard, and ordinance or law coverage.
- Tell your agent about any renovations since the limit was set.
See what your portfolio would cost to rebuild today
Coverage depends on underwriting and the terms of your policy.