Certified Pennsylvania Evaluator Practice Exam

Which principle serves as the foundation for the Cost Approach in property appraisal?

1. The Principle of Demand

2. The Principle of Supply

3. The Principle of Substitution

4. The Principle of Contribution

The correct answer is: The Principle of Substitution

The correct answer is rooted in the Principle of Substitution, which is central to the Cost Approach in property appraisal. This principle posits that a knowledgeable buyer would not pay more for a property than the cost of acquiring a comparable substitute property that offers the same utility. In practice, when appraising a property using the Cost Approach, the appraiser estimates the current cost to construct a replica of the property (considering both the materials and labor involved) and then deducts depreciation to arrive at the property's value. This method emphasizes that the value is based on the cost to reproduce or replace the property rather than its historical purchase price or market demand alone. The other principles, while relevant to real estate valuation in different contexts, do not provide the foundation for the Cost Approach. For instance, the Principle of Demand relates to how buyer interest affects property values, while the Principle of Supply focuses on the availability of properties in the market. The Principle of Contribution pertains to how much a particular feature or improvement adds to the overall value of a property. However, none of these principles directly shapes the framework for the Cost Approach in the same way the Principle of Substitution does.