CHAPTER 2 Economic Principles Principle of Change Principle

CHAPTER 2 Economic Principles • Principle of Change • Principle of Anticipation • Market Equilibrium • Supply • Principle of Competition • Principle of Substitution • Principle of Balance • Principle of Externalities

Change 1. Def. The result of the cause and effect relationship among the forces that influence real property value. Real estate markets are dynamic and subject to constant and immediate change. Change is premised on the cause and effect relationship that takes place in the market. The dynamic nature of the government, economic, social, and environmental forces that influence real property values accounts for change. Change is inevitable and continuous. Change is not always predictable. 2. 3. Opinions of value generally made as of a specific date. The time period in which the value opinion is valid may be relatively brief due to the dynamics of change.

Anticipation Def. The perception that value is created by the expectation of benefits to be derived In the future. Present value is affected by expected future benefits of detriments. Anticipation can enhance or impair value Anticipation varies by property type. Ex. Negative example : Known but not quantified defect that causes buyers to resist because of anticipated repair or maintenance. Ex. Pos example: Values rising in a “hot” market. A delay on sale may include a price increase built into the deal. Anticipation is always focused on the future.

Supply and Demand 1. The nature of supply and demand Real estate markets are created by the interaction of supply and demand. The players are buyers and sellers, or landlords and tenants. The interaction of buyers and sellers effect value directly form sales The interaction of landlords and tenants effect value indirectly from lease amounts which can be converted into value estimates. Market equilibrium: theoretical balance toward which supply and demand of real estate move over time. Never really get to that point because of continuous change An equilibrium point is one where price, cost, and market value are equal. (not likely)

Supply and Demand 2. Supply In real estate supply refers to the number of properties, rental units or raw land parcels available , Appraisal should consider additions to supply in light of projects that are planned or presently under construction. The supply of real estate is dependant on the cost of the agents of production, which are brought together to produce a product. Supply works in conjunction with Scarcity, one of the factors of value. Change in supply generally lags behind changes in demand Property values vary inversely with changes in supply. Ie. supply increase leads to an equilibrium value decline Ie. Scarcity is a supply decline relative to demand, equilibrium price increases.

Demand is not only the desire to purchase goods and services but also incorporates the ability to purchase. Effective purchasing power : the ability of an individual or group to participate in a market ie. To acquire goods and services with cash or its equivalent. Effective Demand: the desire to buy coupled with the ability to pay. When the term demand is used in economics effective demand is usually presumed. 2 Demand is the amount of a property type that is desired for purchase or rent at various prices in a given market for a given period of time. 1.

Principle of Competition Def: The interactive efforts of two or more potential ( purchasers, tenants, sellers landlords) to make a sale or secure a lease. 1. Competition is the interaction of supply and demand. When buyers can choose between multiple similar properties. 2. Moderate profits attract healthy competition Excess profits can leased to ruinous competition. Generally, competitive forces keep excess profits in check.

Principle of Substitution Def: 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 widest distribution. Assumes rational and Prudent markets with no undue cost to delay. The premise is that buyers will not pay more for a property than an equally desirable alternate. Recognizes that buyers and sellers have option. Buyers can look at existing properties or pursue a site to build. Sellers resist pressure to sell or accept an offer that is lower that what it would cost to build a comparable. Opportunity cost is the sub-principle of substitution, it is the cost of options foregone or opportunities not chosen.

Principel of Balance Def: The principle that real property value is created and sustained when contrasting, opposing, or interacting, elements are in a state of equilibrium. The focus is on land improvements. When the combination of land improvements is optimal economic balance is achieved based on the assumption that no marginal benefit or utility is gained by adding another unit of capital. This principle also incorporates a subgroup of principles that show value is affected through the interaction of property components.

Principle of Balance cont’d Increasing and decreasing returns: the concept that successive increments of one or more agents of production added to fixed amounts of other agents will enhance income at an increasing rate until a maximum return is reached. Contribution: the concept that the value of a particular component is measured in terms of its contribution to the value of the whole property, or as the amount that its absence would detract form the value of the property. Surplus productivity: the net income that remains after the costs of various agents of production have been paid. Conformity: the appraisal principle that real estate value is created and sustained when the characteristics of a property conform to the demands of its market. External conformity: property and surroundings Internal conformity: the condition that exists when labor, capital, coordination, and land are appropriately combined in a property.

Principle of Externalities Def: the principle that economies outside a property have a positive effect on its value while diseconomies outside the property have a negative effect upon its value. Positive externality: roads, access, services Negative externality: noise, view of a landfill, odor