If you’re considering buying a real estate property, it pays to understand the workings of the industry so you would know when you should make your purchase. This is especially important if you are planning to join the industry yourself. One major consideration when buying properties as an investment is timing. Of course, you need to understand the economic principles of real estate in order to determine how real estate values rise and fall.

First and foremost, let us define some real estate terms that we are going to use. Value is the use or characteristic of a property to gratify a person’s desire or have control over other properties in exchange. There are three elements of value: scarcity, the rarer the property, the higher its price; utility, how the property is to be used; and demand, the more people in need of it, the higher the price. Cost is the blend of factors of production to produce development. It may be directly or indirectly proportional to value depending on the wisdom behind it. It also depends on the things that were done to the property in the course of time. Price is the expression of a person’s desire for the property in terms of money. It may be higher, equal to, or lower than the value depending on the buyer’s information, whether he was coerced to do it, or depending on how much money he’s got.

Now, there are economic rules for value. The rule of highest and best use says the value of a property is directly proportional to its use. The most plausible use for the property produces this value. It current use is not necessarily its highest value.

Next is the rule of substitution. In theory, every good or service has a replacement or option. The highest value of a property is placed by the cost of attaining an equally attractive and precious alternative property, assuming that there was no costly setback in getting such property.

Then there’s the rule of conformity. This is the concept that a house will most likely increase in value if its size, condition, age, and style is the parallel to other houses in that neighborhood.

The rule of progression states that the value of a house of a lesser quality will appreciate if associated with other houses with a higher quality in the same vicinity.

The rule of regression, in the same note, follows that a property of higher quality that is located in a neighborhood of houses of lower quality depreciates to the same value as that of the said neighborhood.

Last is the rule of increasing and diminishing returns. According to Anne Robert Jacques Turgot, “When one of the factors of production is held fixed in supply, successive additions of the other factors will lead to an increase in returns up to a point, but beyond this point returns diminish.” Therefore, as successively greater augmentations of land, labor, management, or capital are applied to a property a greater yield is created until a summit is reached then there is a decline.

By: Barry Petersen

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