Nationwide Mortgage Licensing System (NMLS) Practice Exam

What economic concept indicates a knowledgeable buyer will pay no more for one property than for a comparable one?

1. Principle of Substitution

2. Principle of Highest and Best Use

3. Principle of Market Value

4. Principle of Intelligent Purchases

The correct answer is: Principle of Substitution

The Principle of Substitution posits that a knowledgeable buyer will not pay more for one property than they would for another that is comparable in terms of utility and desirability. In essence, if two properties provide similar benefits and conditions, the buyer rationally chooses not to exceed the market price of comparable properties. This principle is foundational in real estate valuation and helps buyers understand the limits of what they should pay based on available alternatives. This concept reflects the idea that market dynamics ensure that prices are driven by the properties' comparability. If one property is offered at a higher price without offering additional value, a buyer can simply opt for a comparable property that is more reasonably priced. Thus, the value of a property is influenced by the availability of similar alternatives, and any discrepancies in price are accounted for by the potential buyer’s understanding of market conditions. This principle is a critical concept for appraisers and investors in making sound financial decisions.