What is the difference between property ‘replacement value’ and ‘market value’?
What is the difference between market value and replacement value? And how do bank and municipal valuations relate to these? Mike Addison from Addsure answers your questions...
This is the current cost to replace a building, i.e. to reinstate a property to its original state if completely destroyed.
It excludes the value of the vacant land itself. The replacement value is usually determined by adding the estimated cost to replace the buildings (contract price), professional fees and demolition costs, plus VAT.
This is the price at which a willing buyer and a willing seller agree or would agree to transact a sale.
The estimated market value would be determined by analysing recent sales in an area of similar properties and by taking current market conditions into account, and estimating a price a certain property is expected to fetch if sold at a certain time.
This includes the whole property, i.e. land and buildings, or in the case of sectional title, the unit market value.
Frequently asked questions (FAQs):
Q: Why would the market values and replacement values likely vary?
A: A buyer may be willing to pay a premium for a particular property because, at that given time, there may be a shortage of properties in that area.
For example, a house or sectional title unit in an area near primary and high schools, walking distance from a convenient store, near a public transport system, etc., may fetch a much higher price than the same house 10 kilometers away without those amenities nearby.
However, the cost to replace those houses may be exactly the same.
Q: Could the replacement value exceed market value?
A: Yes, it could. A property, particularly a property in an undesirable area or problem complex, may lack potential buyers. This forces sellers to settle for a much lower price than they may fetch, for example, if the crime rate in an area was reduced.
The cost to replace a building is determined by the cost of materials, contractors’ prices, professional fees, etc., which increases in line with building inflation, versus a scenario where the market value decreases due to the deterioration of the area or property.
Q: Could the replacement value vary from area to area, as does the market value?
A: It could, but if the factors are equal, the values to replace should be equal. In other words, if two properties are similar in size and specification, built on similar land and accessibility is the same, equidistant from resources (delivery costs of materials and labour the same), the replacement value should be the same.
However, the cost to replace would differ when comparing areas like Cape Flats and a cliff overhang nearNoordhoek - the cost of materials and labour, as well as construction costs, will be more expensive in Noordhoek.
Labour and material transport costs will be higher, plus more equipment like cranes may be required at the Noordhoek site.
Building costs also vary from place to place, e.g. on average, building costs in Cape Town may be higher than in Johannesburg at a given time. This is usually measured at a rate per square metre.
Q: Do both market value and replacement value factor in the cost of the land?
A: No. The market value includes the value of the land and in the case of a sectional title unit, it includes that section plus its undivided share in the common property, including the land. The replacement value excludes the land, but will include foundations and services on the property.
Q: Who determines market value and who determines replacement value?
A: The market value is, in reality, only determined when a sale takes place. Therefore, if there is not yet a concluded sale, the closest one can get is an estimated market value which you can obtain from someone who is familiar with, or has access to, property trends and recent sale prices in the area. Such a person would normally be a qualified estate agent, or a property valuer who uses the same methodology.
On the other hand, the replacement value must be determined only by someone suitably qualified to do so, such as a quantity surveyor or registered qualified property valuer. Such a person calculates, with prices and costs, the construction costs, professional fees and demolition costs with a view to determining what it would cost to put that same building back to its original state if reduced to rubble.
Q: What is the municipal valuation of the property in relation to the market valuation?
A: The municipal valuation is the value that the municipal authority places on the property with a view to charging that property a certain tax rate in relation to the municipal rates being charged.
This may be determined in various ways, but presently the municipality assesses the market value at a certain point in time and pegs that rate for a period. These rates are intended to be as close to the estimated market value as possible, but often differ substantially.
Property owners who feel that the municipal value of their property is too high and exceeds market value, usually apply to the municipality to have their municipal value reviewed with a view to reducing their rates. Owners whose municipal values are well below estimated market value usually remain silent and enjoy the benefit of the municipal rate discount.
Q: What is the bank valuation of the property in relation to the market valuation?
A: A mortgage lender or banker who provides property finance against the security of property will usually seek a very conservative market valuation.
In other words, a banker would like to know the net price if they had to sell a property in a hurry, i.e. to realise their security.
So, accounting for agents’ commission and a slightly lower price to encourage a quick sale, one could expect a banker to base a lending value of approximately 80% of market value in a stable property environment. - Mike Addison, Addsure