Problems With Computer Price Estimates

Free to consumer price estimates are popular tools in North America, but they are not without problems. In the coming year or two we expect to see automated valuation modelling being used more widely in Australia – offering either existing or new portal entrants a way to stand out in a rather tough online marketplace. Assuming these tools will become more widespread, one of the best things an agent can do is learn a little about how they work and equally as important – how they don’t work.

AVM basics
Dozens of white-papers and books are available online on both AVMs and home price index methods. However with the exception of a few books written specifically for appraisers in the US, most of the material is written in statistician speak using complex language and symbols. The authors seem to be more interested in impressing their geeky peers than to explain the topics in simple terms.

A computer generated AVM (automated valuation model) uses sales data and one of 3 main techniques to produce a price estimate. The first is a simple ‘Index’ approach, taking the last sale date and sale price and adjusting its value according to market movement. If the last sale price was ‘right’ and occurred within the last 7 years, it is often one or the more accurate models. However in volatile markets or suburbs with few sales to work with, the index can be less reliable. The same data problems that impact AVMs can also impact the Index itself, making it hard to accurately measure how much a market price has changed. So if you combine a dodgy last sale price and a low-turnover market, the Index method can return poor results.

The next method is often referred to as an ‘hedonic’ or ‘regression’ model. Think of this model as estimating a square metre rate for the lot size and a value per bedroom and bathroom. By fitting a straight line to the data, we expect lower prices for smaller homes and higher prices for larger homes, returning a slope value. Once we know the ‘coefficient’ values for lot size and house size, we can estimate the price of the subject property. In homogenous markets with high volumes of sales, the regression model can often work well. However where the quality of dwellings varies significantly or where some streets are more valuable than others, this model starts to struggle.

The third model seeks to match a handful of properties to the subject property. Many AVM companies around the world refer to this approach as the ‘expert model’, as it endeavours to emulate the process used by a professional valuer or real estate expert. This can include looking at sales from the same street and similar streets, matching similar sized lot sizes and house sizes. This approach can also leverage aspects of the two earlier models, using the index to adjust older sales that enter the final comparables list according to any market movement. Size differences may exist, even after the comparables have been selected based on how well they match the subject property (lot size and house size). For example, if one of the comparables is 50 sqm larger in lot size than the subject, the computer can automatically adjust the sale price by the coefficient value ($n x 50 sqm).

Whilst often superior to the regression model, the expert model also has its limitations. The computer will only ever match sales based on what it can measure; this includes time, distance from the subject property, street type, lot size and house size. But as any real-estate agent would know, these measures can often only account for part of the price. Factors such as views, construction quality and street appeal are just a few of the variables that can determine prices in your area.

Challenges for agents
Agent web sites in the US are great sources for stories about ‘Zestimates’ and how they can often adversely impact a listing or sale.

As one first-time buying couple discovered, the Zillow’s ZEstimated value range on a potential new home was $1,100,000 to $1,200,000. SO, while the listed price on the home was over $1.4 million, these buyers cited the Zillow ZEstimate as the reason for their low-ball offer of $1.2 million. Needless to say, the property was sold to another buyer, and at a price well over the Zillow estimate

The problems most commonly highlighted include buyers or sellers not using the AVM as the starting point in the review process. In the case of buyers – some will gravitate to the AVM that is below the value of the listing to support a low ball offer. In the case of sellers, some are drawn to the AVM result that is higher than the true market value. Both situations have the potential to become tricky for agents.

On the whole, most buyers and sellers are smart enough to know the limitations of the models. However agents really need to be equipped to handle every situation.

Tips

  • As you prepare for a listing presentation, run one or two AVMs. If included in your data subscription, you won’t need to worry about transactional costs. If the AVM is available for free online via a portal, this should not be too hard to do. Check if the AVM result is accurate or not relative to the price you think is right.
  • Know your local market and how AVMs perform in your area. If the models are always ‘low confidence’ the AVM report will usually display a red traffic light. Know how to explain this to buyers and sellers who may not notice or appreciate its meaning.
  • Be aware of how unique properties perform via an AVM.
  • Keep of file of AVM reports that show high errors. Showing a few dud results will come in handy when explaining the limitations of AVMs to a vendor.
  • Consider adding property data and AVM methods to your team training.

Kent Lardner
COO PriceFinder

automated valuation model, AVMs, Computer Price Estimates, Index method

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About Kent Lardner

Kent is one of Australia's leading experts on property valuation modelling technology. Kent specialises in property research, property valuations, risk analysis and mortgage processing. Kent is happy to assist your real-estate team with training or tips on property data, appraisals and valuation models.

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3 Responses to Problems With Computer Price Estimates

  1. Ryan O'Grady October 28, 2011 at 12:49 pm #

    Great first post Kent, hope to see a few more.

    I can see a lot of potential headaches for agents managing the expectations of vendors as they always revert back to the AVM. That said, it could also be a benefit for the agent as well.

  2. Patrick Bright October 28, 2011 at 3:07 pm #

    Ken, it’s good to see someone in your position that will publicly admit that property data based reports are flawed for various reasons. Unfortunately many property buyers rely on them far too much and substitute such reports for their lack of time to inspect dozens of comparable properties. Maybe you could be the first company to print a warning on such reports to remind people that they are not gospel when it comes to price. That would be a good duty of care measure I would think.

    I have always advised people to use property sales and data reports but use them cautiously. Property sales reports that you can buy online are a useful tool however people have to be careful as they can give a false sense of confidence about property prices because there’s simply not enough information in these reports to be sure whether properties are comparable.

    How so? Well the reports don’t tell people how many living spaces a property has, the size of the rooms, the condition of the property. Is the property single or double story, unrenovated, renovated or partially renovated – the aspect, and so on. Most will give a land size, but they don’t tell them the shape of the block, if it’s level or on a slope, or if the house is at the front, middle or back of the block. I would think it’s important to know how much of the land on comparable properties is actually useable that the one your after is being benchmarked against, wouldn’t you. All these factors have a big influence on price in fact from my experience (which is considerable) at least 10% and as much as 20% for what would be considered comparable properties in the same or neighbouring streets on data reports.

    Bottom line, there’s simply no substitute for doing your own in-person inspections and detailed research if people want to be sure they are not over paying.

    I think those radio shows where people call up the property data cruncher, give them an address, tell them how many bedrooms and bathrooms the property has then 30 seconds later ‘wamo’ the property you’re looking at buying is worth X dollars are an absolute joke…

  3. Kent Lardner October 29, 2011 at 6:44 am #

    Hi Patrick,

    Thanks for your response – most appreciated. I’m not sure if my company is the first to use a disclaimer on all of our reports, but here is our effort:

    “Pricefinder should be used as a guide only and not be used in lieu of a professional valuation”

    We try and push this angle when we run training sessions or when in media. The consumer market has never really been our focus, but we do know investors and buyers do access the system.

    In terms of buyer convenience, these types of reports are a very helpful tool. But if spending a few hundred thousand dollars or more, it certainly makes sense to get out and inspect listings or drive past comparables, which to your point is critical in determining how comparable a sale is. For interstate investors who are time poor and are known to buy remotely, surely it makes economic sense to engage a local valuer or agent rather than take a risk.

    Your next point; depending on the area, “at least 10% and as much as 20%” of the variation in price is contributed to factors other than size and position from my analysis over the years. I see many locations where in excess of 25% of the value is attributed to ‘omitted variables’. In practice this variation can only really be considered by physical inspection. That said – photos, StreetView, maps with contours and local experience can help a human achieve a much more accurate result compared to a computer alone. Problem with many of the static AVM reports is that the price is the price. You don’t have the option of removing a dud comparable. As with most of these reports, they look so professional and impressive that many consumers would never think of doubting it.

    Your last point regarding the radio show brought back memories. I spent 2 years working behind the scenes for 2UE and 4BC acting as the ‘data cruncher’ for Real Estate Talk. I am not sure how others do it, but the callers actually forwarded the property details about a week or so prior, allowing me to spend an hour or so preparing per property. The really tough ones we forwarded to a local valuer or agent. The ‘instant estimate’ whilst online was never the reality. I am not aware of how other shows do it today, but if relying on an AVM on-air I would be very nervous – some of the callers can be rather savage.

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