If you have just recently completed work on a construction project or are getting ready to develop a home, you should consider using the automated valuation model to determine what the building’s value is. In the real estate industry, the most commonly used type of valuation involves an appraisal, which is performed by a professional appraiser who has the education and knowledge necessary to provide a relatively accurate value for a home or building of any kind.
While a standard appraisal is the most popular type of valuation tool, there are some downsides to this type of appraisal. For instance, human appraisers can take an extensive amount of time to perform the appraisal. It’s also important to understand that two separate appraisers could provide you with two entirely different valuations. In comparison, the automated valuation model is designed to be more consistent and efficient than other valuation methods.
The automated valuation model uses a combination of property/transaction databases and statistical mathematics to calculate the value of real estate. Most of these systems will then compare the estimated value to the values of similar properties. Some appraisers will use the automated valuation model to obtain a final value. Websites like Trulia and Zillow are also outfitted with AVM tools.
When someone is buying a home, automated valuation models allow them to identify the actual value of the home is. If a home is priced at $450,000 but has a valuation of $400,000, this indicates that the listing price may be too high. The buyer could use this information during price negotiations with the seller.
When looking specifically at the permitting process, it’s possible to use the automated valuation model to determine what the value of the finished product will be. As touched upon previously, this model is more accurate than standard appraisals because it takes human error out of the equation. The following guide offers a closer look at the automated valuation model and how it’s used in real estate construction.
Types of Automated Valuation Models
There are four distinct types of automated valuation models that you can use to calculate the value of a building, which include the hedonic, price index, tax assessor, and combined valuation methods. The hedonic method is unique because it uses internal and external factors of the property to determine its value. An external factor that could affect the value of a home is the building’s proximity to a school or park. When a home is in a good location with easy access to some useful amenities, these factors could contribute to the result obtained with the hedonic pricing method.
The price index method is designed to identify how average home prices are increasing or decreasing in a given area. If average home prices have been increasing in a specific neighborhood, the price index method will use this information to determine that the property valuation should increase. As for the tax assessor method, this technique uses the same principles that a tax assessor will use every year to determine a home’s property taxes. These factors include market trends, comparable properties, size, location, type of construction, amenities, and utilities.
Most Used Type of Automated Valuation Model
The automated valuation model that’s used the most is the combined valuation technique. Combined valuation uses all of the aforementioned methods to arrive at a specific value for the building in question. The software that you use to perform this valuation will look at:
- Any recent deed transactions
- Similar property prices
- The most recent property price
- All previous valuations that have been performed, such as the tax assessor valuation
Before you start using any of these techniques, it’s important that you understand how automated valuation models work and if they should be used over standard appraisals.
How Do Automated Valuation Models (AVMs) Work?
The reports that are made from automated valuation models can be generated in seconds when requested by agents and lenders. These reports are made with modern technology and proprietary algorithms. Even though this technology can differ depending on the exact system that a real estate agent or lender uses, most AVM systems contain a hedonic model as well as a repeat sales index, both of which are weighted and fully analyzed before generating an accurate price estimate.
As mentioned previously, automated valuation models usually include the value that the tax assessor arrived at when calculating property taxes. Any useful information about the property will also be input into AVM software, which can include the sales history of the property. If there are any comparable properties in the vicinity of the primary home, the sales information of these properties will also be analyzed.
Even though automated valuation models are primarily used by lenders and real estate agents when they want to calculate the value of a home that’s currently on sale, AVMs are also used during the underwriting process for home equity loans and mortgages. Additional AVM applications include being used for refinancing decisions and aiding in various credit risk management and loss mitigation activities.
While automated valuation models were initially designed to identify the values of residential homes, they have since expanded to commercial real estate. If you would like to use AVM technology, there are many reputable providers in the financial industry, which include Freddie Mac, CoreLogic, and Equifax. However, you can also get this tool for free via a consumer real estate site.
Advantages of an Automated Valuation Model
There are many clear advantages of using an automated valuation model as opposed to a standard appraisal. Most of the advantages result from using an automated piece of software instead of depending on human effort. For instance, AVM software can make complex comparisons and calculations in just a few seconds, after which you’ll be provided with an estimation that’s highly accurate. In comparison, standard home appraisals take a lengthy amount of time to complete.
When a standard appraisal is being performed, the appraiser must physically view the property and compare it to similar properties before they can arrive at an accurate estimate. This kind of research takes an ample amount of time to perform, which means that AVM software will save you time.
Since the appraiser doesn’t need to perform an extensive amount of research, you should also save some money on this process when you opt for the software-based solution. Because of how little time is required to use AVM software, this type of software can be particularly helpful when assessing an entire portfolio of real estate investments.
Another notable advantage of using the automated valuation model is that human error doesn’t factor into the end result. All subjectivity and bias are removed from the equation, which is why you can be confident that the valuation you receive will be most accurate. Keep in mind, however, that computer programs can still be hacked, which means that the data stored in these programs can be manipulated. Even though the risk of data manipulation is present when using AVM software, it’s rare for AVM software to be hacked.
Disadvantages of Automated Valuation Model
While automated valuation models have numerous benefits, there are also a few drawbacks to this tool that keep it from being the clear-cut choice in every situation. AVM software can be highly effective at providing you with precise calculations based on an ample amount of data. However, the data that’s input into the software must be of high quality for you to be confident in the results.
While AVM software can take many factors into account when making calculations, it’s impossible for this software to factor in the property’s actual condition, which can be a problem if the home is currently in poor condition. In general, AVM software assumes that the home is in average condition. If a home is in great condition without any notable blemishes, there’s always the possibility that the software will provide you with a value that’s lower than it should be.
AVM software also depends on comp data, which involves any data about homes with comparable layouts, amenities, and floor plans. If there isn’t much data about comparable properties on record, the automated valuation model may not provide you with accurate results. It’s because of this issue that a home built in the past two years or so can be difficult to assess with an AVM. If you want AVM software to be as effective as it can be, it’s essential that you provide it with relevant and high-quality data.
Another possible disadvantage that comes with using AVM software is that the data you input could be incorrect because of human error. If data is entered incorrectly or isn’t up-to-date, the software wouldn’t be able to provide you with an accurate valuation.
AVM software can be precise and efficient when used for a variety of different applications. However, AVM software depends almost entirely on the quality of the data that the software receives. If there are numerous similar properties in the surrounding area, the valuation you receive from AVM software will likely be highly accurate. On the other hand, the results could be less accurate if the homes in the surrounding area are more varied when it comes to types and styles. If you want to be confident in the results you obtain from an AVM, consider using multiple pieces of AVM software before comparing the results.
Jason Somers, President & Founder of Crest Real Estate
With over 15 years of professional experience in the Los Angeles luxury real estate market, Jason Somers has the background, judgement and track record to provide an unparalleled level of real estate services. His widespread knowledge helps clients identify and acquire income producing properties and value-ad development opportunities.