Ask an Instructor: Replacement Cost

ISA members are invited to send in their questions on all things appraising and education to ISA's instructors. One of ISA's instructors will share answers on the ISA Now Blog. Please send questions to directorofeducation@isa-appraisers.org.


Question: I'm confused as to what to call the insurance value in my appraisal report. Some people call it Replacement Cost, some call it Replacement Value, and some call it Replacement Cost Value. What is the right term that I should be using?

Answer: ISA prefers the term Replacement Cost to be used in insurance appraisals. Why is that? Let's go back to Lesson 1 in the Core Course. Cost is the amount of money paid for an item. Unlike value, cost is not always justified. Just because you paid X amount of dollars for an item, doesn't mean it's worth that much. The monetary worth of an object is its value. Thus, for insurance, when you are estimating the cost to replace an item (either by production, reproduction, or purchase), the correct term to use is Replacement Cost. Other organizations may use the term Replacement Value to mean the same thing as Replacement Cost, but we wish to differentiate ourselves by using the proper words. As for Replacement Cost Value, this term is sometimes used by insurance companies to mean Replacement Cost or Replacement Value, but really it only causes more confusion. Replacement Cost is the most correct term to use.

- Meredith Meuwly, ISA CAPP
Director of Education

Determining Value

Tim Luke, ISA AM, CAI, BAS, MPPA

An essential aspect of our valuation services and specifically in our appraisal practice is determining value. The Uniform Standards of Professional Appraisal Practice (USPAP) provides guidance in the form of a definition of value and a comment as follows, "Value: the monetary relationship between properties and those who buy, sell or use those properties. Comment: Value expresses an economic concept. As such, it is never a fact but always an opinion of the worth of a property at a given time in accordance with a specific definition of value. In appraisal practice, value must be qualified - for example, market value, liquidation value, or investment value."

This one definition is brimming with information and guidance in determining value, so let's take a look at the various elements of the definition. Looking at the first part of the definition, it states, "the monetary relationship between properties..." This means comparing the subject property with comparable items of like kind and quality. It is important to remember when comparing the subject property with comparable items, consideration of all physical characteristics and overall condition must be taken into account to establish a good relationship between the properties. This correlation between the various comparable items with the subject property helps to justify a value conclusion. If similar items under similar conditions are selling for X dollars, than it is reasonable to assume the subject property would sell for X dollars, supporting the value conclusion.

Continuing with the definition, "and those who buy, sell or use those properties." We take into consideration the context of the subject property and comparable properties. Does the subject property possess a certain provenance making it more desirable than other similar items? Is the subject property a rare example? Or was the subject property was mass-produced? This context provides a foundation for understanding the piece and its significance or lack thereof in the marketplace and will provide guidance in determining value. It is our job to understand if buyers are actively seeking out these properties and paying a premium, suggesting an uptick in the marketplace, or if the opposite is true, where there is a large supply and little demand, indicating declining value.

Take Victorian furniture for example. Knowing that the marketplace is inundated with pieces, causing a large supply coupled with a decrease in demand for such items, the values generally go down. However, each piece in an appraisal assignment is evaluated on its own to determine the monetary relationship between the subject property and comparable items to determine the qualified value.

The Comment after the value definition states value is never a fact because it is an economic concept based on an opinion as of a specific point in time in accordance with a specific value definition and must be qualified. The economic concept represents our value conclusion and is an opinion based on research of comparable items in the marketplace as of a specific point in time, taking into consideration the requirements of the value definition for the assignment. Our value opinions are qualified to indicate fair market value, retail replacement value, or other value depending on the assignment. These opinions are established at one point in time and are not to be used at any other point in time or for another qualified value.

In dealing with personal property, remember the various levels of trade for the huge variety of items you will be appraising. These levels include but are not limited to auctions, galleries, retail outlets, flea markets, consignment, garage sales, or the like. They will produce a variety of sales results and depending on the problem you are solving for your client, the selection of the proper marketplace is paramount in order to determine value and provide credible assignment results for your client.

- Tim Luke, ISA AM, CAI, BAS, MPPA has 28 years of experience in the auction and appraisal industry, and is currently the Executive Vice President, Senior Appraiser for Gurr Johns, Inc. based in Florida. He travels the United States doing appraisals, valuations, and brokerage for clients.