SUPPLY AND DEMAND
The principle of Supply and Demand is explained by three inter-related terms:
supply, demand and price
At a given level of supply, if demand increases, then the price increases.
Conversely, given that same level of supply, if demand decreases, then price
decreases.
At a certain level of demand, if the supply increases, then the price decreases.
Given the same level of demand, if the supply decreases, then the price
increases.
Specifically related to real estate, assume that the population in a certain
community is growing by 100 households per year. If there are no additions to
the existing housing stock (supply), the demand will certainly increase, and
prices will accordingly escalate. If the supply is increased by 200 homes per
year, then supply will exceed demand, and prices will tend to decline.
ANTICIPATION
The principle of anticipation holds that value is simply a function of the present
worth of future benefits, that is, people are paying current dollars for future
benefits. These future benefits may take the form of intangibles.
When purchasing investment type property (shopping centers, office buildings,
hotels), the anticipated benefits are future dollars. In other words, the buyer is
exchanging present dollars for property that will hopefully produce more dollars
in the future. The principle of anticipation is the basis for the income approach.
Under this principle, the past is only important because it tends to give an
indication of what is to be expected in the future.
A buyer for a home may look at trends in home prices, and community growth
patterns, all of which have occurred in the past, in order to determine which way
the neighborhood is likely to continue in the future. This past information gives
the buyer insight as to what to pay for the property today.
BALANCE
The principle of balance relates both to the property as well as the
environment in which the property is located. Related to the
property itself, this principle holds that value is achieved and
maintained when all elements are in proper proportion.
The principle of balance also relates to land use. Under the optimum
land use concept, there would be a proper blend of single-family
residences, apartments, complementary shopping centers, nearby
employment centers, and reasonably accessible recreational
facilities. Conversely, a neighborhood that features no convenient
access to shopping, places of worship, or employment would be
considered inferior and result in lower demand and in lower prices.
CONFORMITY
The principle of conformity is similar to the principle of balance, but it
relates more to real estate characteristics.
It holds that maximum value is achieved and maintained when there is
reasonable conformity and not monotonous uniformity among
properties.
A colonial style home in a neighborhood that features all colonial style
homes with some individual variance is desirable. A contemporary ranch
style within this neighborhood would be a nonconforming use; the
market would likely pay less for this contemporary house in this colonial
neighborhood. This contemporary residence would likely sell for more in
a neighborhood that is dominated by contemporary residences.
Conversely, a traditional neighborhood with 300 essentially duplicate
houses would be somewhat monotonous and again result in value loss.
SUBSTITUTION
The principle of substitution is the basis for all
decisions made by real estate buyers and should thus
be the basis of every appraisal and every appraisers
thought process.
Substitution is the process of identifying alternatives
that would satisfy the same need, want, or desire. A
prudent purchaser would pay no more for a home than
it would cost him or her to build or buy another one.
Substitution keeps the market in balance.
SUBSTITUTION
Substitution is the key to the following three approaches to real estate
valuation:
1. The Cost ApproachA buyer would pay no more for a property if he or
she could build one for less.
2. The Sales Comparison ApproachA property with the lowest price
generally will yield the greatest demand if the properties are competitive
and similar in terms of utility.
3. The Income Capitalization ApproachA renter would rent another equal
property if it provided the same utility and satisfaction for less money.
Likewise, if two properties reflected similar risk, return, and management
capabilities, an investor would select the property which is priced less.
EXTERNALITIES
The principle of externalities holds that there are the
following four major forces outside the property limits
that influence value: social, political, economic and
physical/environmental.
The important concept is that value is subjective in its
nature, and the actions of buyers and sellers that create
and maintain value are influenced by forces outside the
limits of the subject propertys boundaries.
Factors affecting land value are discussed later.
OTHERS
Opportunity Cost: The principle of opportunity costs holds that money allocated to a
certain use cannot be used for an alternative.
Consistent use theory involves the concept that land cannot be valued under one
highest and best use while the improvements are valued based on another highest and
best use.
The principle of change holds that as time and market conditions change, so does supply
and demand for real estate, and thus, the value of real estate.
The principle of contribution holds that the value of a component is a function of its
contribution to the whole rather than as a separate component. The cost of an item does
not necessarily equal its contributory value.
The principle of competition holds that profits tend to spur competition. In other words,
success breeds competition, and extremely high success breeds excess competition.
Highest and best use is defined as that logical, legal, and most probable use which will
yield the greatest net income to the land over a sustained period of time. Simply put, it is
the most profitable, logical, and legal use.
