Valuations 101
Optimizing Your Valuation Strategy to Maximize Profit and Minimize Risk
By Kade Clark
Over the past two years, the COVID-19 pandemic has accelerated the adoption of technology and digital processes across the real estate industry, from search to close. For investors, evaluating properties at scale locally, regionally, or nationally requires a technological edge. New valuation tools leveraging the latest advances in artificial intelligence (AI) and data science are making it easier for investors to make intelligent decisions based on data and insights.
There is now a wide range of valuation types available to investors that can help reduce cost, streamline their processes, and more appropriately offset risk. The trick is to use the right tool for the specific scenario. That is why many investors leverage a “waterfall” of multiple valuation products arranged in a cascading order to create a balance of cost, time, and quality that is customized to the organization’s unique needs.
This strategy is most beneficial when cost is a concern or constraint, when staff resources are limited or lack expertise, or when time and efficiency are critical.
Let’s review the different valuation tools widely available in the market and where they might fit in an investor’s waterfall:
Home Price Index
A home price index (HPI) is a tool designed to measure changes in single-family home prices across a designated market. Some of the well-known legacy indices have been around for decades, but there are also newer indices that use modern methodologies to deliver faster, more accurate results.
An example of this is the Home Price Index provided by homegenius Real Estate LLC, which uses the latest data science and analytical technologies to produce micro-market level insights based on the estimated values of more than 70 million unique addresses.
Investors can use HPIs to understand trends in real estate markets and see pockets of investment opportunity and to build a portfolio that increases in value over time.
The modern HPI can provide instant viewpoints on thousands of geographies, including ZIP codes. It can generate a custom index profile for any investor buy box and apply it across markets, provide early indicators of market changes, and can isolate the value difference by attributes within a geography to help identify areas where the cost to renovate an investment or rental property will generate an acceptable return on investment.
Automated Valuation Model
An Automated Valuation Model (AVM) applies statistical modeling to a database of historical property values and sales information to generate an estimated property value. The most popular modeling methodologies are based on average and median house prices, repeat sales or hedonic valuations. AVM results may vary based on the type of statistical modeling incorporated and also by the depth and history of data in the reference database.
Because an AVM is entirely technology-driven, it can be the fastest and most cost-effective way to get a quick value estimate of a home. There is no fieldwork or analysis by an appraiser or real estate agent — which may reduce cost and time and decrease human bias and fraud risk.
AVMs are also tested rigorously for accuracy. AVMs include a “confidence score” that indicates how close the estimate is likely to be to the final sale price. Because of their speed, AVMs are especially useful for bulk portfolio valuation analysis.
Interactive Tools
Since an AVM does not include an inspection of the subject property, it does not account for property condition — including any damages or recent improvements — in the price estimate. Simply put, an AVM will not be as successful if the property’s condition is significantly different from the surrounding comparables.
In scenarios like this, an interactive valuation platform can provide a more detailed view of the property and comparables. These platforms give the user access to photos, maps, and other data simultaneously, leveraging thousands of data points to identify patterns that can be measured and translated. Unlike an AVM, an interactive tool lets users see the condition of the property and hand select the best comparables to reconcile and conclude an estimate of value. Technology and automation make interactive valuation platforms a quick and affordable option as well.
Interactive tools with a rental analysis module can also be helpful to determine the ROI for a potential rental opportunity or help set proper market-rate rental prices. With visibility into comparable rental properties and their prices, interactive tools can provide a complete picture of the rental environment around the subject property.
Broker Price Opinion
A Broker Price Opinion (BPO) is an estimate of the potential selling price of a property that is performed by a local licensed real estate agent or broker. A BPO is typically done as an exterior drive-by but can occasionally include an interior walkthrough. The agent or broker will examine the property at a high level and leverage comparables and basic neighborhood information to develop an estimated opinion of price.
Although the processes sound very similar to an appraisal, the main difference is the professional providing the valuation. Whereas a BPO constitutes the opinion of a real estate agent or broker, an appraisal represents a valuation provided by a licensed real estate appraiser. Incidental differences may include the extensiveness of the inspection, the level of analysis, and the regulations involved. For these reasons, a BPO is cheaper and typically will have a faster turnaround than a full appraisal or hybrid appraisal.
Many investors are familiar with the BPO as it is commonly utilized for single-family rental due diligence because it offers speed and flexibility to get funding quickly. A BPO can be used in place of an appraisal in specific cases, such as a mortgage-backed security review, asset- or portfolio-management or other mortgage loan situations that don’t involve a credit decision.
Hybrid Appraisals
Hybrid appraisals—also sometimes called bifurcated appraisals or evaluations—split the property inspection and appraisal report between two separate parties. First, a property inspection is done by a third party, usually a local real estate agent. Then, they will report their findings to the appraiser, who will gather data from public records, the MLS and other sources to complete the appraisal report. Hybrid appraisals are slightly more costly and time consuming than a BPO. However, they are faster and more cost-efficient than a traditional appraisal since the appraiser is not doing the fieldwork.
Another benefit is the regulatory acceptance of hybrid appraisals and compliance with the Uniform Standards of Professional Appraisal Practice (USPAP) & Financial Institutions Reform, Recovery, and Enforcement Act (FIREAA). Because of this, we are seeing greater demand for hybrid appraisals from certain SFR investors with stricter risk tolerances.
Hybrid appraisals are used frequently in the build-to-rent (BTR) market because the appraiser is able to make extraordinary assumptions of what the property will be worth after construction is completed. Appraisers’ rigorous training allows them to identify comparable market alternatives that are similar in quality of construction, design, location and overall characteristics. They have the knowledge and ability to review builder floor plans, build-out amenities, and locational influences to select the most appropriate comparable sales.
Crafting Your Waterfall
There are many nuances to the level of detail and accuracy these different valuation types provide, and each has a particular use case in an investor’s strategy.
Determining the right combination and sequence of products for your organization can be difficult—it depends on the purpose of the valuation, statutory and regulatory requirements, and the preferred balance of cost, efficiency and risk. The right partner is key and can help you optimize your valuation strategy to maximize profit and minimize risk.
Investors can benefit from working with an experienced valuation provider to build a waterfall to meet their unique needs.
