Foundations of Value Determination and Principles of Price Theory in Real Estate
To understand how real estate value is created and what drives it upward or downward, it is essential to understand the basic economic principles that govern property valuation.
Elements of Real Estate Value
Real estate value arises from four essential elements that must exist together:
Need: The existence of a person who needs the property for a specific purpose.
Utility: The property can be used to satisfy that need.
Scarcity: The number of available properties is limited.
Purchasing Power: The person has the actual financial ability to buy.
Main Principles Affecting Real Estate Value
Principle of Anticipation
This principle states that property prices are influenced by expectations of future prices. Residential units are linked to the availability of services and the social level of the area, while commercial properties depend on market expectations regarding the property’s ability to generate income.
Principle of Competition
This principle states that when demand for a product increases and profits rise, the market attracts similar competing products, which may lead to lower prices and reduced profits unless demand continues to increase.
Principle of Conformity
This principle indicates that a well-maintained property located in an old or poorly maintained area will often not achieve the same return it could generate if the surrounding area were also well maintained.
Principle of External Factors
This principle recognizes that external factors can positively or negatively affect property value. Roads and schools are considered positive factors, while factories and waste stations are considered negative factors.
Highest and Best Use
The most important principle in land valuation is the “Highest and Best Use,” which refers to the possible and physically feasible use of vacant land or an improved property that is legally permitted, financially feasible, and results in the highest value.