Under the principle of substitution, the maximum value of a property tends to be set by:
Correct Answer
C) The cost of acquiring an equally desirable substitute
A purchaser generally compares the cost of acquiring a similarly desirable substitute with comparable utility and no undue delay. Historical cost, asking price and building replacement cost alone do not establish the subject’s market value or include all relevant rights, land and improvement differences.
Why This Is the Correct Answer
Option C is correct because the principle of substitution states that the upper limit of value tends to be set by the cost of acquiring an equally desirable substitute. A rational buyer will pay no more than the cost of a satisfactory substitute, assuming no costly delay. The substitute may be acquired by purchase or by construction.
Why the Other Options Are Wrong
Option A: The amount the current owner paid originally
Option A, the amount the current owner paid originally, is historical cost. Market value reflects current alternatives available to buyers, not what the owner spent in the past.
Option B: The seller's original asking price at the time of the listing
Option B, the seller's original asking price, reflects the seller's expectations. Buyers compare a listing to available substitutes, so an asking price does not set the upper limit of value.
Option D: The replacement cost of the improvements alone
Option D, the replacement cost of the improvements alone, leaves out the land and other value differences. Substitution compares the cost of a whole equally desirable property, not the building cost by itself.
Why pay more?
A buyer asks, why pay more than it costs to get something just as good? That alternative cost caps value.
How to use: Use this question to identify substitution as the principle behind a value ceiling.
Exam Tip
Substitution answers mention an equally desirable or similar alternative. Eliminate choices based on past cost or a seller's list price.
Common Mistakes to Avoid
- -Treating the owner's purchase price as the measure of value
- -Treating the asking price as the ceiling on value
- -Ignoring the land when comparing replacement cost to value
Concept Deep Dive
Analysis
This question tests the principle of substitution. That principle holds that the upper limit of value tends to be set by the cost of acquiring an equally desirable substitute, by purchase or construction. Choose the answer that describes the buyer's alternative, not the owner's history or the seller's hopes.
Background Knowledge
Substitution underlies all three approaches to value. In the sales comparison approach, buyers compare similar properties; in the cost approach, they compare building a substitute; in the income approach, they compare alternative investments. The principle is closely related to opportunity cost.
Real-World Application
A seller lists a home well above recent sales of similar nearby homes. Buyers can purchase a comparable house for less, so the listing sits unsold. The appraiser's value reflects the price of those available substitutes.
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