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Posted on March 11th, 2013, by

Principles relating to the market environment

This group of principles includes the principles of dependence, correspondence, supply and demand, principle of competition and principle of change.
Dependence principle (or the principle of external influence). Various environmental factors influence the value of the real estate object. These factors are divided depending on the extent of their impact on a particular object into major and minor and depending on the sphere of influence into climatic, geological, regional, social, economic, ecological, demographic, legal, international, urban, and technical. In turn, economic factors can also be differentiated according to different criteria: financial, regulatory, and others (Geschwender, 2009). It must be remembered that in all cases, the location is a major factor that influences the price of the real estate object, and the analysis of the value of an object should base on it.

The main factors also include the proximity of the object to the developed infrastructure (connection with the user market): highways, shopping and cultural centers, etc., i.e., the real estate specialist must determine how revenue flows are associated with the user market. These two factors, the location of the object and its connection with the user market, together constitute the concept of economic location of the real estate. This overall factor has the greatest impact on the value of the property. It is therefore necessary to identify and measure the impact of environmental factors on (Geschwender, 2009):

– the value of appraised property and make adjustments to this value, using the method of comparative analysis of sales;
– the amount of cash flow, using the income approach;
– the level of costs in determining the reconstructive cost or replacement cost, using the cost approach.
The problem of differentiating factors that influence the price of the real estate is well studied in the housing market, but less studied in other sectors of the real estate market and therefore requires appropriate attention. The dependence of the value of the real estate on various factors is realized in the form of links, which are measured (estimated) by the amount of time and money spent, and/or distance. Considering the influence of one of the regional factors on the value of the property, for instance a cottage, in particular, its location in a beautiful place (near the lake), you can try to measure this influence by comparing the cottage being estimated with a similar one, but in a less attractive area. The difference in the values of these objects will characterize the relationship between the factor – the picturesque location of the object – and its value in monetary terms.

Correspondence principle. Real estate that does not correspond to currently existing market standards has a lower cost. For example, in the real estate market the value of an apartment in an old building is less than the value of an apartment of the same area in a house built on contemporary designs. The correspondence principle is widely used by architects in the designing urban objects. Building projects must conform to a type of land use in the area. Reasonable architectural uniformity and a high level of services and amenities determine the high cost of the project. Correspondence means the extent to which architectural styles and level of amenities and services offered by real estate meet the needs and expectations of the real estate market (Floyd & Allen, 2008). It should be noted that the needs and expectations of the market change with time and, therefore, correspondence standards change too. Basing on this principle, it is necessary to not only know the correspondence standards for the present real estate market, but also monitor development trends to anticipate the future value of the assessed property.

Principle of supply and demand. Demand for real estate is a real need for them. Supply is the number of objects available in the real estate market and offered for a certain price. The essence of the principle of supply and demand is to identify the relationship between the need for a real estate and the limitations of its supply. Demand for real estate is determined by its utility (ability to meet the needs of the user) and availability, but limited by the paying capacity of potential customers. The lower the demand and higher the supply is, the lower the cost of the object is. And vice versa, if the supply and demand in real estate market is balanced, the market value of the object is stabilized (Ling, & Archer, 2009). It is therefore necessary to forecast the ratio of supply and demand of the estimated real estate property to determine the degree of influence of this relationship and all of the above factors on the cost of the real estate. However, supply and demand ratio does not always determine the price of the real estate. In most cases the selling price also depends on the financing terms of the transaction, the motives (or conditions) of the transaction, awareness and level of competence of contract participants in the issue and other reasons.

Principle of competition. Competition increases dramatically when it comes to super-profits in some form of activity. In competitive condition, the returns on the market exceed the level needed to pay for production factors. Competition, in turn, leads to a decrease in the average level of net income. The real estate market in this regard is no exception. If the super-profits are gained in real estate market, entrepreneurs seek to enter this market. Increased competition leads to an increase in supply in the market. If demand does not increase, the price for real estate in this case reduces and so does the profit of entrepreneurs. On the contrary, when the competition weakens, the supply decreases, and if the demand does not reduce, the prices for real estate and business profits grow. If there is no competition in the real estate market (which happens in a monopoly situation), the market value of an object cannot be determined because the market value is formed in a competitive market only. Knowing that the revenue flow is made up of super-profits, it is (unlike normal cash flow) capitalized on the increased rate as a more risky one (Ling & Archer, 2009; Geschwender, 2009).

Principle of change. Both the real estate object and all the environmental factors mentioned above that influence the object’s cost are subjected to change. The most characteristic types of change are the so-called life cycles. These changes happen with the objects of real estate themselves, as well as areas (cities), and society as a whole. The following basic life cycles can be distinguished (Oprea, 2010):
1. Origination (design, construction of project, formation of community, area, etc.).
2. Growth (period of income growth from the operation of the real estate object, the rapid development of the area (city), society, etc.).
3. Stability, a period of equilibrium (stable income, formed tastes of real estate consumers, developed infrastructure of the area, etc.).
4. Decline (period of reduced demand for real estate, reduced profits, the decline in production in the industry, area, city, etc.).
Taking into account the life cycles, it is necessary to analyze and predict the legal, demographic, international, scientific, technological, urban, social and ecological processes, as well as the reaction of the real estate market to them. The above principles are closely linked to the principle of the best and most effective use of the real estate object and land.

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