About two out of every three homes in America are underinsured. The average underinsurance amount is about 22%, though some homes are underinsured by 60% or more. We saw this firsthand with the Marshall fire and pretty much every natural disaster in Colorado.  Why are so many properties underinsured? How can you determine if you are underinsured?  What do you need to do now?


What is rebuild cost?

The home replacement cost is how much it would take to rebuild your home with similar materials if it’s damaged or destroyed.  Note, even if you built your home recently, the rebuild costs are likely substantially higher than what you originally paid to build.

When you shop for insurance, you will need to specify replacement cost coverage for your commercial or residential property.

What is replacement cost, Market Value, and Assessed value

The replacement cost is different than the market value and assessed value.  Here are definitions of each one:

  1. Replacement cost: This is the cost to rebuild the property as it sits today excluding land value.
  2. Market Value: This is the amount someone would be willing to pay to buy the property as it sits today. For example if you listed your house, this is the price someone would pay to buy it.
  3. Assessed value: This can be radically different than market value and rebuild cost. For example in Colorado, assessments are done in every odd year so for 2021 assessments, they are using sales from 2018 to June 2020.  As we all know with Covid, allot has already changed in a year so this number is likely not an accurate gauge of market value and assessed value.

How is the replacement cost impacted by market value?

Although replacement cost and market value are two different items, market value does influence replacement cost.  For example if you own a property in an area with rapidly increasing values, one of the drivers could be build costs.

Let’s say you own a property in a Ski town, lots in your neighborhood are going for 500k and there are still lots available.  Property values have doubled over the last several years in many ski towns.  More than likely this means your rebuild costs have gone up substantially.

If rebuild costs stayed constant it would be cheaper for someone to buy a lot and build a house as opposed to buying a completed house.  For example if a lot costs 500k and the cost to build is 600/ft, that means  to rebuild a 4k foot house would be 2.4m and to build a new one (add in the land costs) would be around 3m.  If you look around the neighborhood and most houses are now selling for 3m that means rebuild costs have increased (assume you paid 2m for your 4k foot house a few years back).

Although the market value does not per se increase rebuild costs, a steep run up in values is likely an indication that rebuild costs have also increased substantially.

Why are so many more Colorado property owners underinsured?

Colorado real estate throughout the state has seen historic rises in values.  This is occurring on both residential and commercial real estate.  As mentioned above, this historic rise in values is not the driver of higher rebuild costs, but a strong indicator that rebuild costs have increased substantially.  So what is driving rebuild costs higher in Colorado?

  1. Building supply costs: Whether it is lumber, roofing shingles, light fixtures, wood flooring every major building material is up substantially. Lumber costs alone are up almost 300%.  As raw material costs increase so does the cost to rebuild a property.
  2. Labor costs: Along with higher material costs, labor costs have skyrocketed. Just as McDonalds is paying more for workers, builders have substantially increased wages to hire/retain workers.  These costs are passed through to building costs.
  3. Building regulations: As efficiency standards have increased substantially so have building costs.  Take for example in Denver, there are new regulations to achieve net zero buildings.  To meet these standards, there are substantially increased costs for windows, doors, HVAC, insulation, ventilation, etc… all of which add into higher rebuild costs.

What happens if you are under insured?

If you are substantially under insured and there is catastrophic event, you will not receive the funds necessary to fully rebuild the property.  For example, if you had a property insured at 1m, but the rebuild costs are 2m, you essentially lost 1m since you were underinsured.  The insurance company will only be obligated to pay you the max under the policy regardless of your actual loss.

I saw this firsthand with a fire in black forest, a borrower had insured the structure for 100k (that was our loan amount).  I let him know that he was considerably under insured, but he wanted to take the risk.  A wildfire destroyed his house, the rebuild cost was around 400k.  After our mortgage was paid, the borrower had nothing other than a lot with a totally burned house.

Although I used an example of a residential property, commercial property owners have the same risks of being underinsured.


What should you do now to ensure you are properly insured?

  1. Talk with your insurance agent: you should put in a call to your insurance agent, many have tools to estimate the rebuild costs by zip code, also make sure to note of any updates/improvements. Depending on your home value, the insurance company might send an inspector to your house to verify.
  2. Look at market values in your area: If market values have increased substantially, more than likely your rebuild cost needs to also increase substantially as labor and material costs have changed and in many cases building regs have changed.
  3. Talk with a contractor: if you know a contractor, they can typically tell you what the average cost to build is per foot. Multiply this by your square footage to get a rough estimate.  For example, if your house is 4k feet and the cost to build is 400; that means your rebuild cost is around 1.6m
  4. Get an appraisal: You can order an appraisal to determine the market value of your house along with the rebuild costs.  I just got one on my house when I refinanced.  I will use this to double check I have ample coverage.


Millions of American property owners are at risk of major financial loss should a disaster ever affect their property.  Unfortunately, Colorado is more at risk than other areas due to very high building costs which has contributed to skyrocketing values.  With wildfire season upon us and a number already burning throughout the state, now is the time to ensure you are not underinsured to eliminate a financial disaster.


Additional reading/resources



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Written by Glen Weinberg, Owner Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors MagazineThe Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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