Most people believe that if you spend money on improvements to your property, the market value of your property will go up by the cost of the improvement they add, but that is not always the case. Today, we are talking about the principle of contribution, how it works, and what you need to know for the real estate exam.
What Is the Principle of Contribution?
The principle of contribution states that the actual worth of an improvement is what contributes to the property’s market value, not the cost of the improvement.
Worth and cost are not always the same thing when it comes to real estate. For example, a pool could add $5000 to the value of a home but cost $10,000 to build.
An improvement can add more or less value than it costs. For a simplified example, suppose a renovation costs $10,000 and market evidence shows it adds $15,000 to the property’s value. Its contributory value is $15,000; the difference is $5,000 before other expenses. These figures illustrate the concept, not actual construction prices.
Contribution is most commonly applied to determine how renovation and property changes may affect the property’s market value. The principle contribution is one of the many appraisal principles appraisers use to determine fair market value for a property. Appraisers can accurately determine a fair price for properties using the contribution principle, economic principles, contributory value, real estate market trends, and more.
In some of your areas, the principle of contribution is also called the principle of marginal contribution.
Contribution Principle Example
Appraiser Jack was hired to prepare a feasibility study for a 12-unit apartment complex in which the owner is considering putting in a swimming pool. Which basic principle of appraising should Jack use?
Jack should use contribution. Contribution is most commonly applied to determine how renovation and property changes may affect the property’s market value. In this case, since the owner wants a feasibility study, contribution would need to be used. Swimming pools are a typical contribution example.
Buyer demand and local market evidence determine how much a feature contributes. A pool can have different contributory values in two markets even if installation costs are similar. Geography alone does not establish the amount.
Contribution and Prospective Future Benefits
Personal enjoyment and market value are different benefits. You may want a pool for your family even when buyers would not pay enough extra to cover its cost.
For the exam, ask how much value the improvement adds to the whole property. The California Board of Equalization’s appraisal lesson makes this cost-versus-value distinction.
Contribution and the Real Estate Industry
The principle of contribution is used in real estate investing as the whole purpose of investing is to make the most money possible. Remember, as an investor, it’s your job to maximize income, benefits, and capital, so it’s essential to consider the contribution principle whenever possible.
Contribution relates to other areas of real estate as well. A large portion of real estate appraisal includes using different aspects of contribution. Primarily the three approaches to value consider the principle of contribution as one of the main factors, which is more than likely why you’re reading this today!
What to Know for the Real Estate Exam
When exam day comes, you must be familiar with what we discussed today. Remember, the principle of contribution states that the actual worth of an improvement is what contributes to the property’s market value, not the cost of the improvement. Understand how contribution relates to the three approaches to value, real estate investing, and the real estate industry, and you’ll be good to go come exam day.
