In our day to day work, we come across property owners who believe the money spent on improvements will increase the market value dollar for dollar. It’s worth noting that Market Value and Replacement Cost are not the same thing. This article will discuss the different market environments which expose how both work. (Please note, Market Value as mentioned throughout the article is referring to the value in which the structural improvements add to the property)
If you have ever seen a Replacement Value on a property valuation report, it is almost always different to the Market Value allocated to the improvements. It’s important to note that the market environment will dictate whether Market Value allocated to the improvements will be in line with the Replacements Cost.
Replacement Cost or Replacement Value is primarily driven by the costs of building materials, labour costs, professional and local government fees. Costs may vary dependant on the location and the availability of materials and labour.
Replacement Costs can help direct Market Values in some cases. However, the dominant driver of Market Value is supply and demand. Two words you hear a lot when talking about markets.
The easiest way to show how the disparity occurs is to discuss the different market environments.
If supply is higher than demand you will notice that Market Values will be lower than Replacement Costs. In this environment, values tend to be totally disconnected with costs. This is amplified the higher supply is versus demand. Currently, we find a lot of remote communities in this type of market. Buyers can purchase an existing property at a lower price than it costs to build. The laws of supply and demand gives them the negotiating power to do so.