principle of substitution

[Steve Owen]

You are quoting Richard and then directing your rebuttal to me, Moh. But, in fact I agree with him. I don't know whether I agree with you or not because I am not sure I understand what you are trying to say.

Read the link. The principle of substitution does not have to be perfect substitution. You can substitute beef for pork, a mercedes for a ford, or a brand new house for one that's 50 years old.

The principle of substitution does indeed apply to the sales comparison approach. It also applies to the cost approach. It can even be used in application to the income approach, although there, the principle of anticipation is more easily understood to be in effect.

 

[Richard Carlsen]

Moh

Steve did not post that: I did.

And I have not mixed them up.

Cost is what dollar amount the buyer has to pay to acquire the property. Price is the amount of money that is asked, paid, offered or agreed to where a sale or exchange is contemplated. Value is the justified price (an estimate of opinion) made by a trained, knowledgeable person that, in this case, using the Market Value definition, would represent the most probable amount of money to be expected to be paid by a knowledgeable buyer (his cost) to acquire the property.

Value requires justification. Price and cost require no justification.

The Principle of Substitution applies only to the Buyer. It does not apply to the Seller. It is considered by the Appraiser and can be used by the appraiser to defend his opinion of value as justifiable.

 

[moh malekpour]

Steve & Richard,
Sorry for the mixed up with the names, however, you both are mixing apple and orange.
The substitute of something is to supply or produce something. The cost of producing or supplying or substituting something is not the value of that thing. There are times that you can supply something or substitute or replace an item with a certain cost but when there is no demand for that thing, its value would be lower than the cost to produce or supply and substitute it. If you are talking about the market value, you are talking about the demand in the market and if there is no demand, your supply has no value in the market. When you are talking about cost, you are talking about supply, reproduction or replacement or substitution. So, supply by itself doesn't set the market value, it is the demand that dictates the market.

 

[Hal Mann]

Moh, you're missing some basic fundamentals here. I suggest reading the first few pages of the Sales Comparison Approach chapter in any edition of The Appraisal of Real Estate.
Reading that, it should quickly become clear that the principal of substitution is fundamental to this approach.

 

[hastalavista]

So, supply by itself doesn't set the market value, it is the demand that dictates the market.

(Moh, I'm back)

I've never seen a demand curve by itself explain market value.
I've always seen a supply and demand curve to explain market value.

 

[Richard Carlsen]

One cannot and should not attribute market activity or value only to one side of the supply/demand equation or to one particular part of the equation. It is the interaction of all of the market forces that makes the market tend to seek balance.

One of the best examples about such things was told to me by my mentor years ago. It used new houses as an example.

In a balanced market, the cost to build and market a house will equal the price paid by the buyer which will be well justified as the value of the house. There will be a sufficient number of buyers, laborers to build houses, acceptably price materials and affordable, stable financing.

In an over supply market, the market will seek balance normally by price reductions, by fewer houses being built and by reduced costs of labor, materials and profits. Prices paid will typically be lowest at these times and justified values will be lower. Normally, financing rates will decline also to stimulate lending activity.

In an under supply market, the market will seek balance by increased asking prices with scarcity of materials and labor causing increased costs and higher production of numbers of housing units. There will be an excess number of buyers who will aggressively compete for available housing units putting pressure on prices. Prices will typically be at the highest levels at these times with justified values following the increased selling prices. There will be pressure on money supplies to increase returns as funding sources compete for money.

The one thing to always remember is that the market is constantly seeking balance. It is never static. What we say about the market today may not be true in 3 to 6 months. John told me to remember always remember that the market is seeking balance. He also told me to remember that the good appraiser is if nothing, a good historian who is perceptive to current activity and changing trends.

So when one makes a statement that the market is dependent on one aspect or another, I take it with a grain of salt. The market must be examined in the context of the movement of the market, considering as many of the market influences as possible to understand what is going into "making a market".

 

[DTB]

Read the link. The principle of substitution does not have to be perfect substitution. You can substitute beef for pork, a mercedes for a ford, or a brand new house for one that's 50 years old.

The principle of substitution does indeed apply to the sales comparison approach. It also applies to the cost approach. It can even be used in application to the income approach, although there, the principle of anticipation is more easily understood to be in effect.

BINGO,

it doesn't get more intuative than that. I thought everyone understood this before any RE class???

 

[moh malekpour]

One cannot and should not attribute market activity or value only to one side of the supply/demand equation or to one particular part of the equation. It is the interaction of all of the market forces that makes the market tend to seek balance.

One of the best examples about such things was told to me by my mentor years ago. It used new houses as an example.

In a balanced market, the cost to build and market a house will equal the price paid by the buyer which will be well justified as the value of the house. There will be a sufficient number of buyers, laborers to build houses, acceptably price materials and affordable, stable financing.

In an over supply market, the market will seek balance normally by price reductions, by fewer houses being built and by reduced costs of labor, materials and profits. Prices paid will typically be lowest at these times and justified values will be lower. Normally, financing rates will decline also to stimulate lending activity.

In an under supply market, the market will seek balance by increased asking prices with scarcity of materials and labor causing increased costs and higher production of numbers of housing units. There will be an excess number of buyers who will aggressively compete for available housing units putting pressure on prices. Prices will typically be at the highest levels at these times with justified values following the increased selling prices. There will be pressure on money supplies to increase returns as funding sources compete for money.

The one thing to always remember is that the market is constantly seeking balance. It is never static. What we say about the market today may not be true in 3 to 6 months. John told me to remember always remember that the market is seeking balance. He also told me to remember that the good appraiser is if nothing, a good historian who is perceptive to current activity and changing trends.

So when one makes a statement that the market is dependent on one aspect or another, I take it with a grain of salt. The market must be examined in the context of the movement of the market, considering as many of the market influences as possible to understand what is going into "making a market".

Richard,
I would like to get back to my original post on this subject and this is what I said:

Economically speaking, the principle of substitution mostly applies to the replacement cost of the property. The market value of property is mostly related to market approach and principle of H&BU and principle of supply and demand.

I didn't say that the principle of substitution is totally non-applicable. I said that it mostly applies to replacement cost and the priciple of H&BU and supply/demand are more than principle of subtistitution applicable on the market value and market approach.
You should get out of the class room and text books and face the reality of the market. Market doesn't act rationally and is not balanced because the market participants are not acting rationally. the fact of the matter is that the market value will establish mostly based on the principle of supply and demand and H&BU and less on the cost of substitution or replacement.

 

[Mike Boyd]

On November 1, Lop Earned Construction Co. had 7 remaining X plans priced at $450,000 in their inventory. The holidays are approaching and L.E. decided to have a blow out sale the weekend of November 4th and 5th. They parked a VW in every one of the 7 remaining X plan garages, Offered to pay all closing costs including 2 points for a below market buy down interest rate. Those incentives amounted to $35,000 and they sold 6 of those remaining X plan homes that weekend and ended that blow out saleathon.

What is the value the following weekend of that 7th remaining X plan? How long will it remain worth that amount?

 

[Jungle Boy]

On November 1, Lop Earned Construction Co. had 7 remaining X plans priced at $450,000 in their inventory. The holidays are approaching and L.E. decided to have a blow out sale the weekend of November 4th and 5th. They parked a VW in every one of the 7 remaining X plan garages, Offered to pay all closing costs including 2 points for a below market buy down interest rate. Those incentives amounted to $35,000 and they sold 6 of those remaining X plan homes that weekend and ended that blow out saleathon.

What is the value the following weekend of that 7th remaining X plan? How long will it remain worth that amount?

It would depend on whether there are any resales by that time, to put in the sales grid.
I think that the value would be whatever the remaining X plan would fetch in an auction. I'm sure there'd be frenzied bidding going on.