PRINCIPLES OF VALUATION

PRINCIPLES OF VALUATION

A knowledge of basic assumptions, postulates or premises that underlie appraisal methods is essential to an
understanding of the purpose, methods and procedures of valuation. The following principles of value
influences are the more important for a general understanding of the appraisal process.

Principle of conformity. Holds that maximum value is realized when land uses are compatible and a
reasonable degree of architectural harmony is present. Zoning ordinances help set conformity standards.

Principle of change. Real property is in a constant state of flux and change, affecting individual properties,
neighborhoods and cities. The appraiser follows trends and influences and is sensitive to changes in conditions
that affect the value of real estate. Economic, environmental, government, and social forces affect all markets,
especially real estate.

Principle of substitution. This principle is the basis of the appraisal process. Simply stated, value will tend to
be set by the cost of acquiring an equally desirable substitute. The value of a property to its owner cannot
ordinarily exceed the value in the market to persons generally, when it can be substituted without undue
expense or serious delay. In a free market, the buyer can be expected to pay no more, and a seller can expect to
receive no less, than the price of an equivalent substitute.

A property owner states that owner’s house is worth $95,000. Buyers in the market can obtain a substitute
property with the same features and utility for only $90,000. The seller’s house, therefore, has a value of
approximately $90,000, not $95,000.

Principle of supply and demand. Holds that price varies directly, but not necessarily proportionately, with
demand, and inversely, but not necessarily proportionately, with supply. Increasing supply or decreasing
demand tends to reduce price in the market. The opposite is also true.

Principle of highest and best use. The best use of a parcel of land, known as its highest, best and most
profitable use, is that which will most likely produce the greatest net return to the land over a given period of
time. This net return is realized in terms of money or other amenities.

The application of this principle is flexible. It reflects the appraiser’s opinion of the best use for the property as
of the date of his appraisal. At one period of time, the highest and best use of a parcel of land in a downtown
business district might be for the development of an office building; at another time, a parking lot may be the
highest and best use.

A single-family house on a commercial lot may not be the highest and best use for the site. A four-unit
apartment on multiple zoned land suitable for 30 units is probably not the long-term highest and best use of the
land.

The appraiser applies four accepted tests in arriving at the highest and best use for a property. The use must be
(1) Legally permissible; (2) Physically possible; (3) Economically feasible; and (4) The most productive use.

There may be two highest and best uses, one with the site vacant and the other as improved. These must be
reconciled into a final highest and best use determination for the property being appraised.

Determining highest and best use includes assessing potential buyers’ motives, the existing use of the property,
potential benefits of ownership, the market’s behavior, community or environmental factors, and special
conditions or situations which come to bear on appraisal conclusions of value.

Principle of progression. The worth of a lesser-valued object tends to be enhanced by association with many
similar objects of greater value (inadequacy or under-improvement).

Principle of regression. The worth of a greater-valued object is reduced by association with many lesser-
valued objects of the same type (super adequacy or over-improvement).

Principle of contribution. A component part of a property is valued in proportion to its contribution to the
value of the whole property or by how much that part’s absence detracts from the value of the whole. Maximum
values are achieved when the improvements on a site produce the highest (net) return, commensurate with the
investment.

Principle of anticipation. Value is created by anticipated future benefits to be derived from the property. In the
Market Value Analysis, appraisers estimate the present worth of future benefits. This is the basis for the income
approach to value. Simply stated, the income approach is the analysis of the present worth of projected future
net income and anticipated future resale value. Historical data are relevant because they aid in the interpretation
of future benefits.

Principle of competition. Competition is created where substantial profits are being made. If there is a
profitable demand for residential construction, competition among builders will become very apparent. This
could lead to an increase in supply in relation to the demand, resulting in lower selling prices and unprofitable
competition, leading to renewed decline in supply.

Principle of balance. Value is created and sustained when contrasting, opposing, or interacting elements are in
equilibrium, or balance. Proper mix of varying land uses creates value. Imbalance is created by an over-
improvement or an under-improvement. Balance is created by developing the site to its highest and best use.

Principle of four-stage life cycle. In due course, all material things go through the process of wearing or
wasting away and eventually disintegrating. All property is characterized by four distinct stages: growth,
stability, decline, and revitalization.

Single properties, districts, neighborhoods, etc., tend generally to follow this pattern of growth and decline. It is
also evident this process is frequently reversed as neighborhoods and individual properties in older residential
areas are renewed and restored.

Revitalization and modernization in inner-city older neighborhoods may result from organized government
programs or as a result of changing preferences of individual buyers. Most neighborhoods remain in the mature
or stable stage for many years, with decline being hardly noticeable as renewal becomes essentially an ongoing
process.