How to value commercial property for insurance

Any property owner trying to get insurance for their commercial property will need to provide a rebuild cost to get a quote. What figure should you provide? While there are a few rebuild calculators online, these are mostly for residential properties. Commercial properties are harder to estimate and professionals usually get involved. Let's discuss who can help calculate a commercial property rebuild cost, as well as the factors that go into the calculation.

What drives commercial property rebuilding costs?

The rebuild cost of a commercial property is a calculation that reflects all of the costs that would be incurred if the existing structure was damaged or destroyed and needed to be torn down and rebuilt. It's a worst case scenario figure.

Many factors are taken into account when calculating a commercial property reinstatement valuation, such as materials, tradespeople and the size of the property. Professional costs are also included to cover architect, local authority and surveyor costs. And don't forget demolition costs to safely raise and remove the existing structure. Here are some of the factors that might contribute to a commercial property rebuild cost calculation:

Note: rebuild cost is not the same as market value. Consider that the market value of a property includes the cost of the land, which typically does not factor into rebuild cost calculations. Why? Because the land is not usually damaged when a building if affected by an event like fire, flood or burglary.

How to calculate commercial property rebuild costs

While a residential landlord can use BICS calculator to get a rough sense of the rebuild cost for a rented house or flat, calculating the rebuild cost for other types of commercial properties is more involved. For this, professionals are required (Find an RICS chartered surveyor).

Insurance underwriters and banks may want a Red Book valuation, which abides by mandatory rules, best practice guidance and related commentary for asset valuations, carried out by a qualified professional.

Who can carry out a rebuild cost assessment for commercial property?

According to Zurich, insurance valuers, loss adjusters, chartered surveyors and professional reinstatement valuers can all carry out a rebuild costs assessment. However, they say that assessments carried out by insurance valuers, loss adjusters and chartered surveyors can be less accurate if they use pricing tables or indices to calculate the rebuild cost of a property on a cost-per-square-metre basis. This is because these figures will reflect an average value for a particular type of building (e.g., office building); assessments based on average from an index might not reflect unique features of an individual property that can be important for calculating a correct valuation.

However, it is quite common to use a chartered surveyor to get a rebuild cost estimate. For lower-value or easy-to-value properties, a 'desktop' survey may be sufficient (and cheaper, starting from around £175). However, more expensive or harder-to-value properties might require an in-person visit from a valuer, costs for which can easily surpass £1,000. An good insurance broker can help a property owner understand what type of survey is required for a particular situation.

Does the rebuild cost need to be re-calculated every year? Not usually. To calculate rebuild costs in subsequent years after a formal estimate has been provided by a professional, some people rely on linking an original valuation to an index (e.g., inflation). However, this can be ineffective, especially if done over many years. For this reason, many professions recommend getting a new professional valuation every 3 to 5 years to ensure the property is not over or under insured. For example, property inflation in one local area could be much different than another area.

Beware that there can be confusion over which index is best to use. For example, the BICS Review Online tool includes many different indices that one must choose between:

There are also separate indices for everything from labour costs to materials.

However, at least tools like the RICS Commercial Reinstatement Tool do incorporate a location adjustment to help ensure the indices used are giving a more accurate picture based on the area.

Why can a rebuild costs change over time?

There are many reasons why a rebuild cost can change over the years (usually going up!).

These changes alone add up to 30% to property rebuild costs according to Sean Durden, a director at Durden Risk Management Ltd.

Why rebuild cost is critical to get right

It's key to have an accurate rebuild cost on a commercial property to avoid over insuring or under insuring—both of which can lose you money.

Over insuring means you have a commercial property insurance policy with a limit of insurance that is higher than the rebuild value. In that case, you're paying for a limit of insurance that is more than you would ever need and therefore unnecessary. Insurance policies with higher limits of insurance cost more than policies with lower limits, so over insuring means paying a higher premium than is necessary.

Under insuring means having a commercial building insurance policy with a limit of insurance that is less than the rebuild value. Most people aren't aware of this, but under insuring can have dire consequences. In that case, an insurer would typically use a pro rata 'condition of average' to assess a payout, which essentially means that they payout an amount discounted by the same amount you're under insured. For example, if a building is insured for 70% of its rebuild value, an insurance payout would only be 70% of the loss claimed. This even holds true for partial losses, where a claim is less than the limit.

While both under and over insurance are best avoided, it would arguably be better to be over insurance than under insured, as not having sufficient insurance can have dire financial consequences.

For example, take a building with a rebuild cost of £1,000,000 that is under insured for £700,000 (only insured for 70% of its rebuild cost). If a fire causes £400,000 worth of damage, the policy would only payout £280,000 (70% of £400K) leaving the policyholder to cover the remaining £120,000.