REAL ESTATE AND VALUATION
Economic theories related to land
Economic principles of land (realty)
Factors affecting land value (economic principles of land value)
• In economics, land comprises all naturally occurring resources whose
supply is inherently fixed.
• To planners, land is an intangible space on which development
activities take place, contributing to its use and value.
• To farmers, it is the productivity of soil.
• To economists, it is a factor of production besides, labour and capital.
• Land is thus a social and physical entity.
• Real estate is the term defined as the land, including the air above it,
ground below it, any buildings or structures on it, and any natural
resources in it.
• Adam Smith is a classical economist. He based his theory on the basis of
mercantile laws. His theory of How the Nations aquire wealth is based on
the principle of free trade or laizzez faire. We cannot compare the theory
with other two as the fields are different.
• David Ricardo based his theory of rent on the basis of marginal land and
the surplus theory is applied here. He had introduced the concept of Rent
based on the fertility and it is purely dealt with land though this principle is
also applicable to labour.
• Karl marx is a neo classical economist and his theory of surplus states that
the labour is exploited and they had been paid less than their work. For
example, the workers worked for 12 hours but had been paid only for 8
THE LAW OF RENT (NEOCLASSICAL
• Neoclassical (or political) Economics is the name given to an economic theory that was
developed at the end of the 19th and the beginning of the 20th Century in Europe. The
main contributors to this theory were Léon Walras (1834-1910), Alfred Marshall (18421924) and Vilfredo Pareto (1848-1923).
• In this timeline, land was seen primarily as productivity of land and the original and
indestructible powers of land.
• Neoclassical theory of land economics focusses on the marginal productivity of land.
• The Law of Rent states that the rent of a land site is equal to the economic advantage
obtained by using the site in its most productive use, relative to the advantage obtained
by using marginal (i.e., the best rent-free) land for the same purpose, given the same
inputs of labor and capital.
• According to Ricardo, parcels of land differ in their fertility. The most fertile land is put
into production first, and as agricultural production expands less and less fertile parcels
are added; the rent for less fertile parcels is lower than the rent for more fertile land.
ECONOMIC PRINCIPLES OF LAND
• The economic principles related to land are:
• Principle of Supply and Demand
• Principle of Anticipation
• Principle of balance
• Principle of Conformity
• Principle of Substitution
• Principle of Externalities
SUPPLY AND DEMAND
• The principle of Supply and Demand is explained by three inter-related
terms: supply, demand and price
• At a given level of supply, if demand increases, then the price increases.
Conversely, given that same level of supply, if demand decreases, then
• At a certain level of demand, if the supply increases, then the price
decreases. Given the same level of demand, if the supply decreases, then
the price increases.
• Specifically related to real estate, assume that the population in a certain
community is growing by 100 households per year. If there are no additions
to the existing housing stock (supply), the demand will certainly increase,
and prices will accordingly escalate. If the supply is increased by 200 homes
per year, then supply will exceed demand, and prices will tend to decline.
• The principle of anticipation holds that value is simply a function of the present
worth of future benefits, that is, people are paying current dollars for future
benefits. These future benefits may take the form of intangibles.
• When purchasing investment type property (shopping centers, office buildings,
hotels), the anticipated benefits are future dollars. In other words, the buyer is
exchanging present dollars for property that will hopefully produce more dollars
in the future. The principle of anticipation is the basis for the income approach.
• Under this principle, the past is only important because it tends to give an
indication of what is to be expected in the future.
• A buyer for a home may look at trends in home prices, and community growth
patterns, all of which have occurred in the past, in order to determine which way
the neighborhood is likely to continue in the future. This past information gives
the buyer insight as to what to pay for the property today.
• The principle of balance relates both to the property as well as the
environment in which the property is located. Related to the property
itself, this principle holds that value is achieved and maintained when
all elements are in proper proportion.
• The principle of balance also relates to land use. Under the optimum
land use concept, there would be a proper blend of single-family
residences, apartments, complementary shopping centers, nearby
employment centers, and reasonably accessible recreational facilities.
Conversely, a neighborhood that features no convenient access to
shopping, places of worship, or employment would be considered
inferior and result in lower demand and in lower prices.
• The principle of conformity is similar to the principle of balance, but it
relates more to real estate characteristics.
• It holds that maximum value is achieved and maintained when there is
reasonable conformity and not monotonous uniformity among properties.
• A colonial style home in a neighborhood that features all colonial style
homes with some individual variance is desirable. A contemporary ranch
style within this neighborhood would be a nonconforming use; the market
would likely pay less for this contemporary house in this colonial
neighborhood. This contemporary residence would likely sell for more in a
neighborhood that is dominated by contemporary residences. Conversely,
a traditional neighborhood with 300 essentially duplicate houses would be
somewhat monotonous and again result in value loss.
• The principle of substitution is the basis for all decisions made by real
estate buyers and should thus be the basis of every appraisal and
every appraiser’s thought process.
• Substitution is the process of identifying alternatives that would
satisfy the same need, want, or desire. A prudent purchaser would
pay no more for a home than it would cost him or her to build or buy
• Substitution keeps the market in balance.
• Substitution is the key to the following three approaches to real estate
1. The Cost Approach—A buyer would pay no more for a property if he or
she could build one for less.
2. The Sales Comparison Approach—A property with the lowest price
generally will yield the greatest demand if the properties are competitive
and similar in terms of utility.
3. The Income Capitalization Approach—A renter would rent another equal
property if it provided the same utility and satisfaction for less money.
Likewise, if two properties reflected similar risk, return, and management
capabilities, an investor would select the property which is priced less.
• The principle of externalities holds that there are the following four
major forces outside the property limits that influence value: social,
political, economic and physical/environmental.
• The important concept is that value is subjective in its nature, and the
actions of buyers and sellers that create and maintain value are
influenced by forces outside the limits of the subject property’s
• Factors affecting land value are discussed later.
• Opportunity Cost: The principle of opportunity costs holds that money allocated to a
certain use cannot be used for an alternative.
• Consistent use theory involves the concept that land cannot be valued under one
highest and best use while the improvements are valued based on another highest and
• The principle of change holds that as time and market conditions change, so does supply
and demand for real estate, and thus, the value of real estate.
• The principle of contribution holds that the value of a component is a function of its
contribution to the whole rather than as a separate component. The cost of an item does
not necessarily equal its contributory value.
• The principle of competition holds that profits tend to spur competition. In other words,
success breeds competition, and extremely high success breeds excess competition.
• Highest and best use is defined as that logical, legal, and most probable use which will
yield the greatest net income to the land over a sustained period of time. Simply put, it is
the most profitable, logical, and legal use.
Alternatively, the economic principles of land value