Principles of Maximum Yield: Optimal Equilibrium and Resource Optimization

Principle of Balance:

The principle of balance states that production (rate of return❓) reaches its maximum value when the four factors of production (land, labor, capital, and organization) are in a state of equilibrium. An oversupply or deficiency in one factor of production compared to others negatively impacts the property’s value. For example, investing excessively in capital (building a luxurious house on a small plot of land), or a deficiency in skilled labor, or poor organization and management leads to an imbalance in the factors of production, and a decrease in property value.

Example: A plot of land is valued at $20,000. Building a 1,000 square foot house at $50 per square foot results in a $77,000 sale price, representing a $7,000 profit (10% return on the $70,000 investment). However, building a 2,000 square foot house at the same cost results in a $130,000 sale price, representing a $10,000 profit, but the return decreases to approximately 8.3%. The larger house represents over-improvement.

Oversupply of office space in a city lowers the value of all office spaces.

Point of Diminishing Returns:

The point of diminishing returns is the point at which additional expenditures on capital, labor, or management are unable to increase productivity (or value) enough to offset their costs. Adding a fifth bedroom to a small house may not increase its value as much as adding a second or third bedroom.

Mathematical expression: Q = f(L), where Q is the output and L is the number of workers. The point of diminishing returns occurs when d²Q/dL² < 0.

Principle of Surplus Productivity:

This principle assumes the productivity (net income) attributable to capital, labor, and coordination equals their costs. The income remaining after deducting these costs (surplus productivity) can be attributed to the land.

Example: If a property’s net income is $10,000 per year, and the cost of labor, capital, and management is $8,000 per year, the remaining $2,000 is attributed to the value of the land.

Principle of Contribution:

The value of an individual component of a property equals the amount of value it adds to the property as a whole (or the amount its absence detracts from the value of the property as a whole), regardless of its cost. This value is referred to as the Marginal Productivity, while the component’s actual cost is called the Marginal Cost.

Example: Installing new siding on a house increases its value by $5,000. The $5,000 represents the value of the siding and its marginal productivity, irrespective of whether the siding cost more or less than $5,000.

Application in sales comparison: Homes with two bathrooms sell for $140,000, while homes with three bathrooms sell for $145,000. The contribution to value of a third bathroom is $5,000.

Principle of Increasing and Decreasing Returns:

With a gradual increase in the amount invested in one or more factors, the rate of return on investment will initially increase at a gradually higher rate (Increasing Returns). This rate will continue to increase, but at a gradually lower rate, and will eventually begin to decrease (Diminishing Returns).

Highest and Best Use:

The value of a property is determined by the most profitable (and legal) use to which the property can reasonably be put. When analyzing improved properties, the appraiser distinguishes between the actual highest and best use, and the highest and best use if the property were vacant. The appraiser must be aware of the uses permitted under zoning laws.