Substantial Damage and Questions About FEMA’s 50% Rule | Property Insurance Coverage Law Blog

Hurricane Ian caused significant damage to many structures that may not be compliant with current flood elevation maps. If those damaged structures are deemed to have “substantial damage,” the owners may face even greater reconstruction costs to comply with current flood elevations.

I noted this issue in Hurricane Ian Victims Learn About FEMA’s 50% Rule:

What is the 50% Rule? If the cost to repair a damaged building exceeds 50% of the market value of the building, the building must be brought into compliance with the National Florida Insurance Program’s current mapping requirements. The market value is for the building value and not the land value. The value is determined by the county’s property assessment or a licensed appraiser.

My experience has been that many older buildings with significant damage in a flood zone will often not be in compliance with the current flood elevation requirements and will also have damage greater than 50% of the buildings value. The property owner will then have to rebuild the structure at a higher elevation which often means demolishing the structure or raising it.

What is substantial damage?

Substantial damage, as defined in 44 CFR § 59.1, means “damage of any origin sustained by a structure whereby the cost of restoring the structure to its before-damaged condition would equal or exceed 50 percent of the market value of the structure before the damage occurred.” Most damage occurs during a single and sudden event, such as a fire, wind storm, lightning strike, falling tree, tornado, earthquake, flood, or natural gas explosion. Damage may also be unrelated to a specific event, such as soil settlement, exposure to the elements, termite infestation, vandalism, deterioration over time, and other causes.

Can I avoid falling into a definition of “substantial damage” by not doing all the repairs? The answer is “no:”

If a local official determines that a damaged building… has incurred substantial damage, then the structure must be brought into compliance with floodplain management (and building code) requirements for new construction based on flood zone. Work necessary to restore a substantially damaged structure to its pre-damage condition constitutes substantial improvement, regardless of the actual repair work performed. Therefore, when the NFIP regulations refer to substantial improvement, repair of substantial damage is included.

Even if an owner proposes to perform less than all of the work necessary to repair the damage completely, the determination must be made on the cost to fully repair and restore the structure to its pre-damage condition.

If the total repair costs are equal to or greater than 50 percent of the structure’s pre-damage market value, the structure must be brought into compliance. The same requirements for structures that are substantially improved apply to structures that are substantially damaged.

Who Makes the Determination of Whether a Structure is Substantially Damaged?

Local officials are responsible for reviewing the validity of all cost estimates provided by applicants, whether prepared by licensed contractors, engineers, architects, professional cost estimators, or property owners. When applicants submit professional appraisals of market value, local officials should examine the documentation to determine whether the appraisals reflect the specific characteristics of the buildings. Local officials also should inspect damaged buildings and manufactured homes to verify that the proposed costs include all work necessary to restore the structures to pre-damage condition.

Estimates may be used for both costs and market values. To be consistent, local officials should decide and document in advance the estimation methods that will be used, especially in post-disaster situations when many damaged structures may need to be evaluated to determine whether they have been substantially damaged.

When using estimates, the closer the ratio of estimated costs to estimated market value is to 50 percent, the greater the accuracy needed to make the SI/SD determination. Especially in the post-disaster period when using estimates to focus attention on the structures for which additional data are needed, local officials may decide that if the ratio of estimated costs compared to estimated market value is less than 40 percent, no further evaluation is necessary because the work obviously does not constitute SI/SD. Using that same logic, the community may decide that if the ratio is greater than 60 percent, no further evaluation is necessary because the work obviously does constitute substantial improvement. However, when the ratio falls between 40 percent and 60 percent, the local official may require the applicant to provide a detailed list of costs or to obtain a professional appraisal of the structure’s market value.

How Is Market Value Determined?

Market value refers to the price that a seller of real property can expect to receive from a buyer in a fair and open negotiation. For SI/SD determinations, only the market value of the building or manufactured home is important (land, land improvements, and accessory structures are excluded). In addition, the market value must always be based on the condition of the structure before the improvement is undertaken or before damage occurred. If structures have not been maintained and have deteriorated over time, then the pre-improvement or pre-damage market values are the values as of the date applications for permits are submitted.

Many communities require permit applicants to obtain appraisals of market value prepared by qualified professionals who are licensed to perform appraisals in the State or community where the properties are located. In addition, three other methods can be used to estimate market value:

• Values developed for property tax assessment purposes, adjusted to approximate market value
• Estimates of a structure’s actual cash value, including depreciation
• ‘Qualified estimates’ based on the professional judgment of a local official

Can Actual Cash Value or Replacement Cost Values Be Used To Determine Fair Market Value Of The Damaged Building?

If depreciated to account for physical conditions, then actual cash value (ACV) or replacement cost value (RCV) can be used to estimate market value.

ACV is the cost to replace a structure on the same parcel with a new structure of like kind and quality, minus depreciation due to age, use, and neglect. ACV does not consider loss in value due simply to outmoded design or location factors. Depreciation accounts for the physical condition of a structure. The concept of ACV is used in both the insurance industry and the construction industry. In most situations, ACV is a reasonable approximation of market value, provided depreciation is accounted for.

RCV is the cost to replace a structure on the same parcel with a new structure that is intended for the same purpose and using comparable materials and quality (at the present day cost of materials and labor). The concept of RCV is also used by both the insurance industry and the construction industry. Definitions may vary from State to State.

RCV can be estimated easily, even when a large number of damaged structures must be assessed. Therefore, local officials may find it useful to use RCV to estimate market values during the post-disaster period.

What Items Are To Be Included In The Costs To Repair?

‘Costs to repair’ include the costs of all work necessary to restore a damaged building or manufactured home to its pre-damage condition. Both include the costs of all materials, labor, and other items necessary to perform the proposed work. Most costs must be included, although certain costs may be excluded.

Applicants for permits must provide estimates of the cost of the proposed work. Acceptable sources of cost information include:

• Itemized costs of materials and labor, or estimates of materials and labor that are prepared by licensed contractors or professional construction cost estimators.

• Building valuation tables published by building code organizations and cost-estimating manuals, and tools available from professional building cost-estimating services.

• ‘Qualified estimates’ of cost prepared by the local official using professional judgment and knowledge of local and regional construction costs.

• Structure owners may submit cost estimates that they prepare themselves. Owners should submit as much supporting documentation as possible.

Items that must be included in the costs of improvement are those directly associated with the work being done on a building or manufactured home. The costs of repairs must include all work necessary to restore a structure to its pre-damage condition. Whether determining costs of improvement or costs of repairs, the determination must include costs associated with complying with any other regulation or code requirement that is triggered by the work. Any list of costs that must be included cannot be exhaustive; however, the following list characterizes the types of costs that must be included:

• Materials and labor, including the estimated value of donated or discounted materials and owner or volunteer labor
• Site preparation related to the improvement or repair, such as foundation excavation or filling in basements
• Demolition and construction debris removal
• Labor and other costs associated with demolishing, moving, or altering structure components to accommodate improvements, additions, and making repairs
• Costs associated with complying with other requirements and codes that may be triggered by the work
• Construction management and supervision
• Contractor’s overhead and profit
• Sales taxes on materials
• Structural elements and exterior finishes, including:

•Foundations
•Monolithic and other types of concrete slabs
•Bearing walls, tie beams, trusses
•Joists, beams, subflooring, framing, ceilings
•Interior non-bearing walls
•Exterior finishes
•Windows and exterior doors
•Roofing, gutters, and downspouts
•Hardware
•Attached decks and porches

• Interior finish elements, including:

•Floor finishes
•Bathroom tiling and fixtures
•Wall finishes
•Built-in cabinets
•Interior doors
•Interior finish carpentry
•Built-in bookcases and furniture
•Hardware
•Insulation

• Utility and service equipment, including:

•Heating, ventilation, and air conditioning (HVAC) equipment
•Plumbing fixtures and piping
•Electrical wiring, outlets, and switches
•Solar panels and equipment
•Light fixtures and ceiling fans
•Security and fire, smoke, and CO2 warning systems
•Built-in appliances
•Central vacuum systems
•Water filtration, conditioning, and recirculation systems

What Items Can Be Excluded When Calculating The Cost To Repair?

Items that can be excluded are those that are not directly associated with the structure. The following list characterizes the types of costs that may be excluded:

• Clean-up and trash removal

• Costs to temporarily stabilize a structure so that it is safe to enter to evaluate and identify required repairs

• Costs to obtain or prepare plans and specifications • Land survey costs

• Permit fees and inspection fees

• Carpeting and recarpeting installed over finished flooring, such as wood or tile

• Outside improvements, including landscaping, irrigation, sidewalks, driveways, fences, yard lights, swimming pools, pool enclosures, and detached accessory structures (e.g., garages, sheds, gazebos)

• Costs required for the minimum necessary work to correct existing violations of health, sanitary, or safety codes

• Plug-in appliances, such as washing machines, dryers, and stoves

The answers to these common questions are found in a FEMA Pamphlet 213 on the topic, Answers to Questions About Substantially Improved/Substantially Damaged Buildings.

Policyholders, adjusters, and contractors need to be aware of these federal regulations. If a building is deemed “substantially damaged” and was not in compliance with the flood maps, it potentially impacts the insurance recovery loss measure and the amount it will take to rebuild the structure-assuming the structure can even be rebuilt.

Thought For The Day

There is no such thing as free regulation.
—John Hutton

Chip Merlin

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