A buyer wants a home like the subject. An equally desirable existing home is available now for $425,000. Alternatively, the buyer could buy a lot and build an equally desirable home for a total of $398,000, but it would take 12 months, during which the buyer would pay $2,500 per month in rent. Under the principle of substitution, what upper limit of value is indicated?
Correct Answer
B) $425,000
The upper limit is set by the cost of acquiring an equally desirable substitute, by purchase or construction, and a significant delay raises the cost. Building costs $398,000 + (12 x $2,500) = $428,000, so the cheaper substitute is the existing home at $425,000. Ignoring the delay gives $398,000, averaging the two gives $426,500, and $428,000 is the more expensive substitute.
Why This Is the Correct Answer
Option B is correct because the build alternative really costs $398,000 + (12 x $2,500) = $428,000 once the delay is counted. The existing home at $425,000 is the cheaper equally desirable substitute, so it sets the upper limit of value.
Why the Other Options Are Wrong
Option A: $398,000
Option A, $398,000, uses the build cost without the cost of the 12-month delay. Adding 12 x $2,500 = $30,000 makes building cost $428,000, more than the $425,000 existing home.
Option C: $426,500
Option C, $426,500, averages $425,000 and $428,000. Substitution looks to the cheapest equally desirable alternative, not an average of alternatives, so the limit is $425,000.
Option D: $428,000
Option D, $428,000, is the delay-adjusted cost of building. A buyer would not pay that when an equally desirable home is available now for $425,000.
Cheapest equal substitute caps value
Price each substitute including any delay cost, then take the lowest; that is the ceiling.
How to use: Use this when a question offers buying versus building, or two substitutes with different timing.
Exam Tip
Always add delay costs before comparing substitutes; skipping them is the usual trap.
Common Mistakes to Avoid
- -Ignoring the cost of delay in the construction alternative
- -Averaging substitutes instead of taking the cheapest equally desirable one
- -Treating the higher-cost substitute as the value ceiling
Concept Deep Dive
Analysis
Two steps are needed: add the cost of delay to the construction alternative, then compare it with the purchase alternative. A rational buyer pays no more than the cheaper equally desirable substitute, so the lower of the two delay-adjusted costs sets the upper limit.
Background Knowledge
The principle of substitution states that the upper limit of value tends to be set by the cost of acquiring an equally desirable substitute, either by purchase or by construction. When acquiring the substitute involves a significant delay, the cost of the delay must be added, which in effect raises the substitute's cost.
Real-World Application
A client asks whether to buy a resale home or build on a lot. The appraiser notes that rent paid during a year of construction pushes the build option above the resale price, so the resale market sets the practical ceiling.
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