greatest demand and widest distribution. This is the

Basic Appraisal Principles Chapter 14 Flashcards The 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."

Physically PossibleIt must be physically possible for the use in consideration to be performed on the property. The site must be level enough, deep enough, have enough frontage, and have adequate subsoil conditions. It may require public utilities to be available at the site.Let's go back to the fast food possibility. Suppose our subject property is zoned to permit retail operations such as a fast food restaurant.Let's assume the property is well located on a busy street with lots of traffic, so it would be economically feasible. All that sounds great, but the property only has 30 feet of street frontage. It would be physically impossible to erect a typical Burger King or McDonald's on a site that is so narrow.The 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.The principle of supply and demand is defined as: "In economic theory, the principle that states that the price of a commodity, good, or service varies directly, but not necessarily proportionately, with demand, and inversely, but not necessarily proportionately, with supply. In a real estate appraisal context, the principle of supply and demand states that the price of real property varies directly, but not necessarily proportionately, with demand and inversely, but not necessarily proportionately, with supply."That is a rather long-winded definition that basically says if something is in short supply it generally will command a higher price - and vice versa. The principle of supply and demand makes the world go 'round. It is the most basic of the underlying economic principles.It works in all areas. If cars are scarce, dealers can charge more. If there is an oversupply of cars, the dealers need to cut prices to be competitive. I don't care if we are talking about

comparing stocks, real estate, apples, or bagels. Supply and demand are crucial elements in pricing and in the ultimate values achieved.The theory states that price and demand have a direct relationship. If demand is high, that means prices are high. And of course, if demand is low, prices will also be low. If you think about it, it just makes sense.The theory states that price and supply have an inverse relationship. In other words, if there is a large supply of a product or service the price we can charge will probably be reduced. This will have a direct effect on competition for that product or service. It is just human nature that buyers will flock to lower prices.Of course the opposite is true as well. If there is an undersupply of any given product or service, buyers will be competing for the limited supply, and it will drive prices upward. Classic economic theory says that supply and demand will tend to move towards a point of equilibrium.If there is an undersupply of anything, for example houses, new ones will be produced to try to fill the gap. If there is an oversupply of commodities, such as cars, production can be trimmed to decrease the supply and sales incentives can be applied to increase the demand.Unfortunately, with real property, the supply side of the equation is relatively fixed and slow to change, whereas the demand side of the equation can change quickly (the principle of change). For example, a large local employer might expand and hire 500 new people in the span of a month. This will immediately increase demand for housing in the area. Assuming supply and demand for housing are currently in balance, the influx of new workers will result in a temporary undersupply of housing. It might take builders and developers a year or longer to construct enough houses or apartment units to meet this new demand. You can't just snap your fingers and create new housing units.The principle of change is defined as:"The result of the cause and effect relationship among the forces that influence real property value."Change is constant. Real property values are dynamic and subject to constant and immediate change. It doesn't mean that values change every day, but that they are capable of dramatic and instant change.As the definition states, this is the result of a cause and effect relationship, or tug-of-war, among the various forces that interact to influence real property values. These are the external market factors that are categorized as Social, Economic, Governmental, and Environmental. We covered these back in Chapter 12.In

some cases, these changes are subtle and hard to recognize. But it's all part of an appraiser's due diligence to properly analyze all factors to determine their value. The big, drastic changes are easy to recognize (such as a factory closing) but may be hard to quantify in the short term. Perhaps the change (i.e., the market event) occurred so recently that the appraiser cannot find market evidence of how buyers and sellers are reacting to this happening.Economically 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