The principle of substitution is fundamental to which appraisal approach(es)?
Correct Answer
A) All three, through substitute sales, costs or investments
Substitution underlies all three approaches: buyers compare competing sales (sales comparison), the cost of building an equally useful substitute (cost) and alternative investments with comparable income (income). Applying it requires equivalent utility and relevant market constraints; it does not make reproduction cost or any one return automatically equal to value.
Why This Is the Correct Answer
Option A is correct because substitution underlies all three approaches. In sales comparison, buyers compare competing sales; in the cost approach, they compare the cost of building an equally useful substitute; in the income approach, they compare alternative investments with similar income. Applying it still requires equivalent utility and attention to market constraints.
Why the Other Options Are Wrong
Option B: The income and cost approaches, but not sales comparison
Option B says substitution applies to the income and cost approaches but not sales comparison. Sales comparison is the approach most directly based on substitution, since buyers compare competing properties for sale.
Option C: The cost approach only, through the cost of a new substitute
Option C limits substitution to the cost approach through the cost of a new substitute. The cost approach is primarily based on substitution, but the principle also covers purchase of an existing substitute and alternative investments.
Option D: Sales comparison, but not the cost or income approach
Option D says sales comparison but not the cost or income approach. The cost approach relies on the cost of constructing a substitute and the income approach on alternative investments, so both also rest on substitution.
Buy, build or invest
A buyer's substitutes are buying another property, building one, or investing elsewhere: the three approaches.
How to use: Use this to recall that substitution applies across sales comparison, cost and income approaches.
Exam Tip
If an answer limits substitution to a single approach, check whether another option covers all three.
Common Mistakes to Avoid
- -Linking substitution only to the cost approach
- -Excluding the income approach from substitution
- -Assuming reproduction cost automatically equals value
Concept Deep Dive
Analysis
This question tests the reach of the principle of substitution. Substitution says a buyer will not pay more than the cost of an equally desirable substitute, and that substitute can be an existing property, a newly built one or an alternative investment. That logic supports all three approaches to value.
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, by purchase or construction. Buyers choose among competing options of similar utility. Each approach to value models a different form of that choice.
Real-World Application
An investor considering a rented duplex compares asking prices of similar duplexes, the cost to build new, and the returns from other income properties. The appraiser's three approaches mirror those same substitute choices.
More Sales Comparison Questions
Which stated cause of supported value loss is external?
Improvement cost new is $450,000. Separately supported improvement depreciation deductions of $45,000, $25,000, $15,000 are expressly nonoverlapping and not already excluded from cost new. Add supported site value of $125,000, already reflecting any site losses. What total indicated value results?
Which two depreciation categories may each be classified as curable or incurable by comparing the cost to remedy a deficiency with the value gained?
Improvement cost new is $800,000. Separately supported improvement depreciation deductions of $120,000, $80,000, $40,000 are expressly nonoverlapping and not already excluded from cost new. No site is included. What depreciated improvement amount results?
The principle of anticipation in real estate valuation states that:
Which highest-and-best-use criterion addresses whether a proposed use is allowed by zoning and applicable legal restrictions?
Three comparables produce adjusted indications of $312,000, $309,000 and $315,000, requiring gross adjustments of 9%, 14% and 22% respectively. Verification also establishes that the first sale is the closest competitive substitute and its adjustments are better supported than the other two. Which indication deserves the most weight on those facts?
When reconciling value indications from the three approaches to value, an appraiser should:
A property sold at a cash-equivalent price of $1,062,500. Its stabilized annual NOI is $85,000. What is the indicated overall rate?
In reconciliation, an appraiser should:
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