In previous columns, we’ve talked about something called an AVM or automated valuation model. These are computer programs that attempt to determine the market value of property. In keeping with the computerization of most everything we do, AVMs are becoming a more frequently used tool for both buyers and sellers, as well as real estate professionals. Nevertheless, AVMs are still a crude method of valuation, and the degree of accuracy they provide is limited. But, along with other methods, AVMs can play a role in drilling down to determine what most would consider a reasonably good estimate of market value.
When we work to create a consensus of market value, the process starts with broad-stroke estimates of value, such as AVMs, and then we narrow the funnel with other methods to gradually arrive at a range that should be within 2 percent to 4 percent of the actual selling price. From least accurate, to most accurate, those valuation methods or data points used include: Government assessed value, an AVM, interactive AVMs, an appraisal, and finally, a comparative market analysis (CMA) performed by a local real estate agent. Here’s how each of those methods and/or estimates differ:
Every three years, the government reassesses the value of property for the purposes of determining real estate taxes. Because of the volume associated with this process, the government must use mass-appraisal techniques. They also employ proprietary AVMs to help get the job done.
Anytime mass-appraisal techniques are employed, the degree of accuracy with respect to individual properties is going to be diminished. That’s why there is an appeal process. It gives property owners a chance to correct the inaccuracies of a mass appraisal. Government assessments can sometimes be on target, but they can become dated in a fast moving market or fail to adequately take into account changes to a property or unique characteristics that might drive a higher value. Plus, if we’re looking at a property where there are large numbers of very similar properties (like a townhouse or condo), we might give the assessed value more consideration than we would if it were a very specialized property, such as many waterfronts. All in all, we’ll take a look at the assessed value, but we don’t give it much weight.
Automated valuation model (AVM)
Zillow was one of the first websites to make AVMs available to the public. The Zillow AVM is called a Zestimate. For the most part, a Zestimate isn’t much more than a calculation that averages the sales price of homes that might, or might not, be similar. As a result, a Zestimate could be very inaccurate. According to Zillow’s chief economist, Stan Humphries, the error rate on Zestimates when they first started was almost 14 percent, which means they could be off by $70,000 on a $500,000 house. That’s huge. Zillow has made some improvements, but even so, their average error rate is still almost 7 percent. Zestimates are better than a wild guess, but not a whole lot better. Generally, a Zestimate is similar to a government assessment in terms of accuracy.
As we move up the ladder of accuracy, the next rung is something called an interactive AVM. These combine public record information on home sales with local multiple list system data and predictive economic modeling to provide what is called a “Bank Grade” automated estimate of value. In fact, banks use these types of AVMs when trying to value large blocks of property, such as their inventory of foreclosed homes.
Just like the name implies, an interactive AVM also allows the user to make changes to certain property features and thus improve accuracy. For example, you can adjust things like the lot size, number of beds and baths or square footage to better reflect the property being valued. But, even interactive AVMs lack the ability to perform the finer corrections necessary to account for things like the quality of finishing, location and other important variables that can have a big impact on value.
Having a certified appraiser put a number on a house can be a pretty tight estimate of value. Appraisers will search out similar homes that have recently sold and then make adjustments for differences between the subject property (the home they’re trying to value) and the properties chosen as comparables. Once the differences are identified and the appropriate dollar amounts are inserted to accommodate for those differences an appraisal generates an estimate of value based on this equalization of the subject property with the comps.
This process can be one of the most accurate, but it also has some flaws. First, an appraiser might not be intimately familiar with a certain area. So, they might choose comparable properties that aren’t entirely similar to the subject property. As we all know, location is everything, and even if two homes are physically the same, where they are located can have a tremendous effect on what they’re worth. In some communities, moving a house even a block or two could appreciably change the value.
Second, the numbers an appraiser uses to equalize a subject property with the comparables aren’t always appropriate for where the house is located. To illustrate, a pool might have value in certain climates or communities, or it could be looked at as a deterrent to value in others. Third, appraisers don’t always fully consider the finer details of a property and how those details relate to prevailing market conditions.
Comparative market analysis (CMA)
A CMA is created by a real estate agent and commonly recognized as the most accurate way to value property. To a large extent, agents will go through the same process as an appraiser, looking for comparables and making adjustments for how the subject property is different. However, real estate agents can add the dimension of experience and judgement regarding the value of certain features, the demand for homes in that particular neighborhood, current market conditions, the type and amount of competition, buyer preferences, property conditions, staging, presentation, as well as many other factors that are important, but perhaps less well defined.
As you can see, there are many ways to determine the market value of property, and no one way is the be all, end all to getting an accurate answer. In many ways, the type of property has a lot to do with how much horsepower you need to get the job done. Like we said, with a condo or townhouse, where there are many sales of similar properties, some AVMs might do a pretty good job of getting a good number. However, even those types of properties can have important differences, difference that can only be defined and quantified by an experienced real estate agent. So, it might be fine to start with an assessment, Zestimate, but if you really want a precise estimate, get the opinion of a real estate agent, and better yet, get the opinion of two or three agents. Only then, will you have an accurate understanding of what your house is worth, along with what will and what won’t affect the sales price.