What does the principle of substitution refer to in property appraisal?

The principle of substitution in property appraisal holds that a property's value is directly related to the cost of acquiring an equivalent substitute. This means that if a buyer is considering purchasing a property, they will not pay more for it than the cost of purchasing an equally desirable property with similar utility. Essentially, if two properties offer the same benefits and one is priced significantly higher than the other, the buyer will substitute the lower-priced option, thus underscoring that the market value is limited by the cost of alternatives.

When applying this principle, appraisers utilize comparable property data to help determine a property’s market value. If a property is priced above what a similar property could be purchased for, that higher price would be considered unreasonable in the eyes of the prospective buyer, who is likely to seek out the more economically sensible choice. This helps ensure that property valuations remain consistent and align with the broader market.

The other concepts, though relevant to real estate, do not encapsulate the principle of substitution accurately. They discuss considerations such as market demand, the unique value of distinct properties, or the value added by improvements, all of which do not specifically speak to how value is measured through substitution.