AAIS member companies are familiar with e2Value, Inc. as an AAIS strategic business partner that provides residential, commercial, and farm property valuation applications available to users of AAISdirect.

There is, then, perhaps no one better than Todd Rissel, president and CEO of e2Value to respond to questions about how the collapse of real estate values is impacting construction cost estimates used to establish building property limits.

Companies have long faced the problem of mortgage lenders and insureds insisting that Coverage A homeowners limits needed to match mortgage balances.

Indeed, trends in housing values and construction often move in tandem, Todd tells us in the following interview, but they haven’t since around 2004. Now insurers have to face questions and complaints from some homeowners whose devalued homes would cost more to replace than they are worth in today’s market, and from other homeowners whose inflated mortgage balances do not merit an equivalent reconstruction cost.

Todd spoke recently with Viewpoint editor Joseph Harrington.

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Viewpoint: What impact is the decline in housing values having on construction cost valuation?

Todd Rissel, e2Value: Housing values have an impact on construction cost valuation from the standpoint of how they are affecting material prices, how they are affecting labor and demand, and how they are affecting people staying in business.

Michigan, unfortunately, was a state that was leading the way in declining housing values, and it’s bled down into northern Ohio and Indiana, as well. In those areas, you saw a leveling off of construction costs while the rest of the country was still moving up at that time. Now the rest of the country is following suit.

Viewpoint: We know there is considerable confusion among homeowners between market value and replacement cost in setting the Coverage A limit. Are you hearing anything about this in this market?

Todd Rissel, e2Value: Absolutely. We hear it in the good markets, and we hear it in the not-so-good markets.

Homeowners are reacting because they see in the news reports that $2 trillion
dollars of value has been lost, and that houses are 30% below the price they were a year ago. They naturally think that their insurance costs should be going down,
that their limits and premiums should
correspond.

Viewpoint: Can we separate the recession and its impact on construction costs from falling real estate values themselves?

Todd Rissel, e2Value: Well, we separate them. They are different and distinct.

Even though you’re seeing a 30% drop in market value, what you didn’t see, when the market values were going up 30-40-50 percent, was a corresponding escalation of replacement cost. A lot of the housing price increases were related to speculation and had no real basis of value other than that somebody could get a loan.

Sometimes there is a fairly good correlation between market value and replacement cost value. In this particular process, starting in 2004, there was a separation between market value increases and construction costs. At that time, the corresponding increase in construction costs were probably 10 or 12 or 15 percent, about half of the market value increase.

That’s hard for a lot of people to understand. We had a case of a house in Maryland in 2005. It was literally bought and sold four times in six months. You went from one price of $150,000, and six months later it was being sold for $400,000. Agents for this particular insurance company were complaining that the replacement cost value was not reflective of the true cost of the house. We showed how this house went from a market value of 150 to 400 in six months based on all those sales.

That had nothing to do with replacement cost. It was still an 800 square foot home. An 800 square foot home’s replacement cost did not jump four times or five times just because of the bubble effect of the financing.

Now that that $400,000 house is probably back on the market for $200,000, everyone looks at that and says, “Gee, that’s a 50% loss in value.” But, from our perspective, when you’re following construction costs, it’s a slow, steady increase in cost along the way.

Viewpoint: Are you detecting any continued pressure from mortgage lenders or the secondary mortgage market agencies to have Coverage A limits or valuations equivalent to mortgage balances? Do you hear anything about that?

Todd Rissel, e2Value: We hear about that all the time.

When someone has a $400,000 mortgage on an 800 square foot home, all they understand is that the amount of the mortgage is $400,000 and they are required to have $400,000 worth of insurance.

So they look at us and the other replacement cost providers and say, “Your replacement cost should be reflective of that mortgage value.” We can’t do that. We just give you an idea of what it would take to replace a particular structure at a particular time with particular features. We aren’t driven by the mortgage value.

Insurance carriers were being asked by the lenders to put a $400,000 limit on a $150,000 home, and we were under tremendous pressure to correspondingly increase the replacement cost. We didn’t do that.

Now, that person has probably lost that house and moved on. A new buyer is probably looking at $150,000 in replacement costs. The mortgage company is a little more aware of what a real true value is, and they’re more aware of the fact that the replacement cost is a good baseline to give them an idea for what the real market value of a home should be.

Always, from all my time, 25 years in the business, through up cycles and down cycles, there is that pressure to correlate the replacement cost with the mortgage value, and the two are not related.

Viewpoint: How does the situation compare for commercial properties? How are their construction cost valuations being impacted by the real estate market and the recession? Is there any parallel to what’s happening in the home market?

Todd Rissel, e2Value: There is now, although nine to 10 months ago, commercial construction was still
moving along fairly well.

Commercial construction does have a boom and bust cycle to it, but the boom in commercial construction was not like the boom in housing.

The problem for commercial construction was the pressure on materials pricing. Don’t forget, now that oil is $39 or $37 a barrel, that not too long ago it was $147 a barrel, and all of the things that use oil were going up [in price]. Platinum was going up, copper was going up, all of the things that were related to building were dramatically increasing in price.

Commercial construction was also impacted by the cost of labor because you could make so much more money as a laborer on residential projects. When the residential market fell out, the commercial market was still fairly strong and, at that point, could take advantage of the price drops for commodities and labor. Unfortunately, in the last two months, after the debacle with the personal lending and mortgage-backed securities, commercial lending is now having some issues.

Because of the valuation of assets on everybody’s books, there’s a lack of lending. It’s not that there isn’t capital, but lenders are not lending it because they’re not sure what’s around the next corner.