The principle of substitution – a buyer will not pay more for a property than the cost of an equally desirable alternative property.
Although this real estate term is often used in the appraisal world. The Principle of substitution can be applied when you are looking to buy or rent a home. This principle is similar to a market comparable (often used when determining how much to list a home for), but only involves properties that are on the market and available.
For example, if you have a buyer that can purchase a brand new 3 BR/ 2 BA house in Miami for $1,000,0000, why would that buyer pay $1,200,000 for the same house in the same neighborhood with the same quality? They wouldn’t according to this principle of substitution.
In the rental world, the same rules apply. Why would a potential renter pay $800 for a 1 BR unit in an apartment complex when he can get a different unit in the same complex for $600 a month?
Do you follow the logic here?
This is why prospective home sellers should listen to the market and not price their house too high. The people buying your house won’t overpay and listing for more than the market value is a waste of everyone’s time.
However, there are a few exceptions to the rule. Think about Michael Jackson’s Neverland Ranch or a house that some people consider haunted. This could have an effect on the pricing because it is rare.