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Top 10 primary principles OF REAL ESTATE VALUATION

  1. Progression. This principle relates to one way in which market value rise. Expressed as a statement, progression tells us, “A property’svalue may increase due to the existence of similar properties in simi- lar locations, containing greater quality.” The idea that a rising tidelifts all ships applies here. In fact, progression is also expressed by the maxim that you profit in real estate by buying the worst house on agood block.
  2. Regression. The opposite rule may work as well. A falling tide canlower all ships or, as the regression principle reveals, “A property’svalue may decrease due to the existence of similar properties in simi-lar locations, containing lower quality.” So an exceptional house maynot appreciate as one would expect if and when other houses—even on the sale block—are outdated, obsolete, or poorly maintained. Thisconcept is closely related to the third principle in real estate valua-tion, that of conformity.
  3. Conformity. This concept is, “A property is most likely to appreciatin value along with other, similar properties in the same neighbor-hood.” So if an investor spends a lot of money to upgrade a house,style. If the neighborhood consists of 2,000 square feet, three-bed-room, two-bath homes 10 years old, improving property above that standard may not be profitable. Converting a home by adding 500 square feet and changing the internal layout to four bedrooms and three baths could be money poorly spent, based on the principle of conformity.
  4. Substitution. In real estate, comparison rules the way that valua-tion trends become established. Thus, progression, regression, and conformity are primary concepts. A variation on this theme is that of substitution. This principle is, “A property’s greatest potentialmarket value is limited by the market value of other, similar prop-erties.” Thus, it would not be realistic to judge market value in avacuum. Without considering the market value of similar proper-ties located in similar areas, we cannot accurately analyze market value of any property. This theory is easily observed. When two similar properties are for sale, the lower-priced one will tend to sell first and, as a result, the market value of the remaining property may be lowered.
  5. Change. This principle tells us, “No condition remains the same in definitely; change is part of the economic cycle.” Property values areaffected by change in several ways. These include local economicand demographic trends, physical age and condition of the property and surrounding properties, character of a neighborhood or city,and natural events like disasters (hurricanes and earthquakes, for example).
  6. Anticipation. Real estate investors—like those in all markets—ar continually estimating the future value of properties. The principle of anticipation may be stated as: “Market value often is affected by ex-pectations about future events.” For example, if an investor believes that a particular area is likely to experience growth in coming years,that would mean property values would rise. The very expectation actually increases demand, and valuation rises as a result. The cause and effect can be more immediate than the time it takes for the cause to occur. If a proposed rezone is in the works, properties in the af-fected area could experience rise or fall in property value in anticipa-tion of the change.
  7. Contribution. This principle acknowledges a limitation on growth in market value, notably in the case of improvements. The additional market value one may expect from improving property is not equal to cost, but to the contribution those changes make to actual market value. Thus, in a low-demand market, an improvement may add only $2,000 to market value even though actual cost was $5,000. In the case of cosmetic repairs to properties in hot markets, the opposite ef-fect may be seen as well. Contribution tells us, “Improvements add to market value as a factor of current supply and demand, and not nec-essarily on the basis of actual cost.” The principle of contribution can also be defined as being controlled both by increasing returns and by diminishing returns. In other words, making improvements to prop-erty will cause growth in market value to an extent (increasing returns), but when improvements exceed that level, return on investment begins to fall (diminishing returns).
  8. Plottage. This principle observes that consistency in ownership of
    land and zoning or usage, tends to maximize value. The principle states that, “Land values tend to increase when adjacent lots are combined into single ownership and put to a single zoning or use.” This phenomenon is observed when a series of relatively small lots remain under-developed and are eventually purchased by one per-son or company and subsequently developed. Each individual would be unable to organize such a development when many own-ers are involved.
  9. Highest and best use. Closely related to plottage is the principle
    that “Real estate valuation is maximized when land is utilized in
    the best possible way.” Thus, rich farm land should be used to
    grow crops and land located within sight of an interstate freeway is
    best used for highway commercial zoning. The same observations apply to all forms of zoning and usage. Real estate valuation is un-usual in that sometimes 10 one-acre plots are worth more than one 10-acre plot. An analyst needs to compare land size to proposedland use, and be prepared to adjust valuation based on a site’s vari-ance from the idea.This means looking at far more than just zoning and its obvious attributes. Zoning is only one aspect, one expert has observed:How many times have we seen statements in reports that con-clude that the highest and best use of a property is as zoned? Highest and best use, by definition, includes the legal, physi-cal, and economic benefits of ownership, plus social commit-ments to a community at large.”
  10. Competition. The last primary principle of valuation is directly re-lated to the broader concept of supply and demand. The principle of competition states, “Opportunities for profitable investment lead to competition.” This has ramifications for valuation of all properties. A good idea is going to be imitated or duplicated. Thus, as long as de-mand remains unchanged, the emergence of competing properties will tend to dilute market value for all similar properties.

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