3.1 The Concept of Value and Economic Principles
Key Takeaways
- Value, price, and cost are three different numbers; only value reflects the present worth of future benefits to a typical buyer
- The four characteristics of value are Demand, Utility, Scarcity, and Transferability (DUST) — all four must be present
- The economic principles of substitution, highest and best use, conformity, and supply/demand drive nearly every appraisal exam question
- Substitution is the foundation of the sales comparison approach; highest and best use is the foundation of every value conclusion
- Anticipation, contribution, and the principle of increasing/decreasing returns explain why an improvement may not add dollar-for-dollar value
3.1 The Concept of Value and Economic Principles
Value is one of the most heavily tested topics on the national salesperson exam, and it begins with a precise vocabulary distinction. Three words look similar but mean different things, and the exam writes questions specifically to see whether you confuse them.
- Value is the present worth of future benefits arising from ownership. It is an opinion, not a fact.
- Price is the amount actually paid in a completed transaction. A price already happened.
- Cost is the dollar amount spent to create the improvement (labor plus materials plus builder profit).
A brand-new pool may cost $60,000 to build, but if buyers in that neighborhood only pay $25,000 more for a home with a pool, the pool added $25,000 of value. Cost does not equal value, and the difference is the single most common value-vocabulary trap.
Market value
Market value is the most probable price a property should bring in a competitive and open market under conditions of a fair sale. The standard definition assumes specific conditions, and the exam expects you to recognize all of them:
| Assumption | Meaning |
|---|---|
| Willing buyer and seller | Neither is under duress |
| Reasonable exposure time | Property was marketed openly for a typical period |
| Informed parties | Buyer and seller each act knowledgeably and in self-interest |
| Cash or equivalent terms | Price is unaffected by special or creative financing |
| Arm's-length transaction | Parties are unrelated and independent |
If a question describes a sale between two relatives, a foreclosure, or a quick sale at a discount, that price is not reliable evidence of market value because one or more conditions failed.
The four characteristics of value — DUST
For value to exist at all, four characteristics must be present simultaneously. Memorize the acronym DUST:
- Demand — the desire to own, backed by purchasing power.
- Utility — the property's usefulness for its intended purpose.
- Scarcity — a limited supply relative to demand.
- Transferability — the ability to convey ownership with clear title.
If any one element is missing, value collapses. A landlocked desert parcel may have utility, scarcity, and transferability, but with no demand it has little market value. Water in the ocean has demand and utility but no scarcity, so it commands no price.
A quick memory device: a property must satisfy all of DUST at once. The exam often gives a scenario missing exactly one element and asks why the property has little value — identify the missing letter.
Value in use versus value in exchange
Two additional value concepts appear on the exam. Value in use is the worth of a property to a specific owner for a specific purpose, which may differ from its market value. A factory custom-built for one manufacturer may be highly valuable in use to that company but worth far less to anyone else.
Value in exchange is market value — what the property would bring from a typical buyer in the open market. The difference matters because an owner's personal attachment or specialized use does not establish market value. The exam may also reference investment value (worth to a particular investor given their goals) and assessed value (the value a tax assessor places on property for ad valorem taxation), neither of which equals market value.
A swimming pool costs a builder $55,000 to install, but homes with pools in the neighborhood sell for only $20,000 more than comparable homes without pools. Which principle and figure best describes the pool's effect?
The economic principles that drive value
The exam tests a cluster of economic principles. Each one is a likely standalone question, so learn the one-line definition and a quick example for each.
Substitution — A buyer will pay no more for a property than the cost of an equally desirable substitute. This is the single most important principle because it is the entire foundation of the sales comparison approach and a check on the cost and income approaches.
Highest and best use — The legally permitted, physically possible, financially feasible, and maximally productive use of the land. Every value opinion assumes the property is at its highest and best use. A small house on land zoned for a high-rise may be valued for the land's redevelopment potential, not the house.
Supply and demand — Value rises when demand exceeds supply and falls when supply exceeds demand. Real estate supply is slow to adjust because building takes time, which causes price cycles.
Conformity — Maximum value is reached when properties are similar in size, style, and use. A 5,000 sq ft mansion among 1,200 sq ft cottages is over-improved and will not return its full cost (the related principles of regression, where a superior property loses value among lesser ones, and progression, where a modest property gains value among superior ones).
Anticipation — Value is created by the expectation of future benefits, such as an upcoming transit line raising nearby prices today.
Contribution — A component adds value equal to its effect on the whole, not its cost. Linked to the principle of increasing and decreasing returns: improvements add value until a point, after which additional investment returns less than it costs.
Two more principles: competition and change
Competition holds that profit attracts competition, and excess profit tends to attract so much competition that profits are driven back down. When one strip mall earns high returns, developers build more nearby until the surplus disappears. This is why an appraiser studies the supply pipeline, not just current rents.
Change reminds the appraiser that nothing remains static: neighborhoods move through four stages — growth (development and rising demand), stability (equilibrium), decline (falling demand and deferred maintenance), and revitalization (renewal and reinvestment). Because value is tied to a specific date, an appraisal is only valid as of its effective date. A trap question may ask why an appraisal made last year may no longer be reliable — the answer is the principle of change.
An appraiser is asked to value a vacant lot. Current zoning allows a single-family home, but the lot could be rezoned for a profitable apartment building that is physically possible and financially feasible. However, the rezoning has not yet been approved and is uncertain. Under highest and best use analysis, which use should the appraiser most likely conclude?