Chapter 14 The Economic Principles Flashcards

Chapter 14 The Economic Principles Flashcards Principle of ConformityThe principle of conformity is defined as"The appraisal principle that real property value is created and sustained when the characteristics of a property conform to the demands of its market."This principle is closely aligned with the principle of balance. It postulates the premise that properties fare better when they meet the expectations of the market.When properties are unusual or atypical, they may suffer a loss in value. There are more buyers for properties that exhibit characteristics that are commonly in demand. An ultra-contemporary house built in an historic New England village may find very few takers. Whereas, an historical reproduction of a Victorian or American Colonial house may be out of place in Miami Beach and become a hard sell.Be aware, however, that the demands of the market can and do change over time. They also will vary considerably by area, price range, etc. It will require diligent research by the appraiser to be able to judge pertinent factors accurately.Principle of ExternalitiesThe principle of externalities is defined as"1. The principle that economies outside a property have a positive effect on its value while diseconomies outside a property have a negative effect on its value.2. In appraisal, off-site conditions that affect a property's value. Exposure to street noise or proximity to a blighted property may exemplify negative externalities, whereas proximity to attractive and well-maintained properties or easy access to mass transit may exemplify positive externalities."This means that good things or bad things can happen to your property's value based on what is located around it. This isn't confined to good or bad houses nearby, but could describe the influence of a number of external factors such as exposure to hazards, convenience to work or shopping, adequacy and cost of government services, proximity of recreation, quality of schools, etc.Unlike most other economic principles we are discussing, this principle is applicable primarily to real estate, because of its immobility. If someone is having trouble trying to sell 100 pairs of snow skis in San Diego, for example, they can just ship the skis to Denver and sell them there (or sell them online to buyers who live in Denver). However, if someone constructs a mansion in a $100,000 neighborhood and they are having

trouble selling it, they do not have the option of moving it to Beverly Hills. Real estate is a prisoner of its environment, and its value is affected by factors outside the property's boundaries.Principle of SubstitutionThe principle of substitution is defined as"The appraisal principle that states that when several similar or commensurate commodities, goods, or services are available, the one with the lowest price will attract the greatest demand and widest distribution. This is the primary principle upon which the cost and sales comparison approaches are based."The principle of substitution is the basic principle that underlies all three of the appraisal approaches to value. Of the three approaches, the sales comparison approach relies most heavily on the principle of substitution. The principle is used to price practically everything. If Wal-Mart sells a bag of chips for $2.50 and Safeway sells the same bag for $3.00, consumers will go to Wal-Mart.In appraising, the principle basically says, "I won't pay more than $200,000 for your house, because I can buy another one just as good for $200,000." That is the principle that underlies the sales comparison approach.This concept is important for residential appraisal, because although all homes are different, they are also more or less replaceable. So the value of a home tends to be set by the cost to acquire an equally desirable substitute. The concept assumes two

important things: (1) that there will be no long delay in

acquiring a substitute, and (2) that a buyer will accept a substitute.Similarly, sometimes you will find that substitute properties lack important features of the subject, making them less desirable to buyers; or vice versa. So appraisers note all significant characteristics of both their subject and comparables when using the sales comparison approach.Another way of determining substitution value is to look at the cost of new construction. What would a new house of similar value cost to build - assuming that it could be built in a reasonable amount of time? In this case the refrain is, "I won't pay more than $200,000 for your home, because I can build another one just like it for $200,000." That is the basis for the principle of substitution in the cost approach.You can also use the principle of substitution to value income properties. Here, one might say, "I won't pay more than $200,000 for your income property because I can buy another one with similar income returns and financial benefits for $200,000." Economically FeasibleEconomically FeasibleThe third requirement is that the use of the property be economically feasible and result in a viable investment. We don't want to hear that refrain of "build it and they will come." We need to have evidence that the use being considered is currently feasible, or will be feasible in the very near future.You might have a 50-acre parcel that has no zoning and is level and open. It even sits on the intersection of two state highways. At first blush, you might consider it to be a prime site for a regional shopping mall of 200 stores.However, if it is located way out in a rural area and 50 miles from the nearest population center, it just won't fly. It would be lucky to survive the first year of operation. There just isn't sufficient traffic in this location for a regional shopping mall to be economically feasible (i.e., profitable).So we have to factor that into the equation. Even if a property passes the tests of legal permissibility and physical possibility, it must have a viable market and demand for that type of use. You must investigate the supply and demand situation.Economic PrinciplesThere are basic economic principles that form the foundation of real property appraising. Some of them have

been around for centuries.Many of these principles can be applied in general to all economic endeavors. For example, supply and demand is just as important when selling furniture, vegetables, or oil as it is in selling real estate.Some of these principles have a more direct effect on real property than others, for example, the principle of externalities.