When you’re buying a house, you probably want to find a good deal — and you definitely don’t want to overpay! So you might be wondering: If you base your offer on an online property value, can you trust that number?
With some 2021 buyers making offers on homes sight-unseen, that online property value has become increasingly important. But before you decide if you can trust that number, it’s important to understand what property value is, how it’s typically calculated, and where an online property value assessment can go wrong.
What is property value?
Property value is how much a house is worth (or would be worth) if the owner were to list it for sale today.
That said, there’s some nuance and subjectivity to property value. The same house could be worth different amounts to two different buyers, for example, if it has a feature that one buyer strongly desires and the other buyer can take or leave.
Ricky Ruiz is an agent in Las Vegas who completes 15% more sales than other agents in his area. He points out that if homebuyers go to the three major real estate portals — Zillow, Trulia, and Redfin — for property values, “you’ll get three different numbers, so you should at least look at all three,” when estimating a property’s value.
Who determines property value?
Property value is typically determined when a property is bought, sold, or assessed for tax purposes. Depending on the situation, a different professional will determine the home’s value.
Real estate agents and buyers
Real estate agents might help a seller determine how much a house is worth when it’s listed for sale. Typically, a listing agent will prepare a comparative market analysis, looking at recent sales in the seller’s area, to determine the selling price. But pricing a house can also be a strategic decision — the agent might advise a seller to underprice a house in hopes of sparking a bidding war.
Ruiz thinks that the downside of using an online property value to set a home’s selling price is that these models “calculate things in the past from a market value standpoint, and you don’t want to list where the values have been, but where they’re going.”
Because automated valuation tools use public records to determine how much similar homes sold for, they lag the market. There can be weeks or months between when a house is listed for sale, an offer is made, the deal closes, and then it’s recorded publicly and available to the AVM. Since it can take two or three months from when the house was listed for sale for the model to factor that sale into its comps, a human is going to know better than a computer what is happening right now just by virtue of the data lag.
As a result, an experienced agent could suggest that you offer more or less than a property’s list price.
A house will be bought and sold for what the buyer and seller agreed in the offer if the buyer is paying cash. With an all-cash purchase, the house is worth what the buyer is willing to pay (though it would be a good idea for them to get an independent appraisal to confirm the home’s value; after all, it’s a big investment!).
Mortgage lenders and appraisers
If the buyer is getting a mortgage, then the lender also has a stake in the home’s value. The lender wants to make sure the house will be worth enough to recoup their investment if you stop making payments on the mortgage loan and they have to foreclose. So they’ll have a licensed appraiser determine the home’s market value.
Tom Cullen is a licensed real estate appraiser certified by the National Appraisal Institute, and he has been appraising homes for more than 30 years.
According to Cullen, “a full appraisal includes a thorough inspection of the property, both interior and exterior. Appraisers are looking for quality, condition, and attributes that would make that home more or less valuable than the comparable sales in your area.”
An appraiser has years of training and certifications supporting their calculation of a property’s value.
A tax assessor also calculates a home’s property value regularly for tax purposes. In some states this is done regularly, which can mean annually (such as in Massachusetts), or at intervals as long as five years (such as in Idaho). In other states, the assessment is done when the home changes hands and then will be increased by a certain percentage annually (such as in California).
The government has an interest in knowing how much your home is worth; if property values aren’t reassessed on a semi-regular basis, it could result in over- or under-payment of property taxes.
How is property value calculated?
Appraisers almost always calculate property value through comparable recently sold listings, or comps, but insurance companies and tax assessors use other methods.
When an appraiser determines property value with a sales comparison approach, the appraiser looks at recent sales in the vicinity and figures out which sales best match the house they’re appraising. They try to find comps that are as close to the house being assessed as possible — comps with a similar number of bedrooms and bathrooms, square footage, lot size, and number and type of outbuildings.
The cost approach of valuation is a method of calculating property value most often used by insurance companies.
When you purchase a homeowners insurance policy, you can typically select from two different coverage levels: one that would pay out the current market value of the house, or one that would pay to rebuild the house from the ground up, which is typically the more expensive option.
The replacement cost approach calculates the cost to rebuild at current market prices for materials and labor. Because it almost always results in a higher cost than buying an existing house, the premiums on a policy with replacement coverage will be higher.
Tax assessors calculate value depending on how much sales prices have increased in the county or area. They use a formula that can vary nationwide. Some cities offer exemptions for a portion of paid property taxes, and many cities and counties may charge higher taxes for an income-generating (or rental) property. Assessors make adjustments for differences between comparable properties, subtracting value if your home has one fewer bedroom, or adding value if it has an ocean view.
Because each of these professionals is calculating property value for a different purpose, you can expect to see some variation in values.
Do online property value tools work?
Automated valuation models, or AVMs, use some of the same data as an appraiser or tax assessor. But they’re calculating value for a different purpose — to draw eyeballs to the website for marketing and lead generation purposes. While they try to get it “right,” they lack the experience of a local agent in your market.
Here are five reasons why an online property valuation tool might get it wrong.
Data issues and automated valuation models
Some AVMs have a wider margin of error than others. According to Cullen, “the places where those values work well are larger states with homogenous neighborhoods where the only difference from one home to the next is one has a one-car garage, and the second home has a two-car garage.”
Most online property value tools draw on multiple listing service, or MLS, data. Because they look at recent sales in the home’s area to determine value, they claim to be similar to an agent’s comparable market analysis. But websites choose comps using an algorithm, and that algorithm might or might not work well in your specific area.
Tools are only as good as the data that goes into them, which is referred to in the tech industry as “GIGO” — “garbage in, garbage out.” If there’s missing information that the algorithm can’t access — like a new roof, or a remodeled kitchen — the value will be inaccurate.
A home could also have a scenic view, or waterfront access, and while some algorithms could include this data, other algorithms will not. Information that can’t be input into an automatic calculator, and can only be seen in person, also influences a home’s value, such as the finishes on the interior, or clues about home maintenance.
Home condition and online property values
AVMs can’t walk through a house to see what condition it’s currently in and whether there have been upgrades. They pull data from the same ZIP code but might not know, for example, if one low-elevation house’s backyard is up against a creek that frequently floods, and another next door is on slightly higher ground.
While some online tools have a way for homeowners to input repairs and the age of major systems and appliances, they can’t track how well the home has been maintained. There’s also no way for them to know if the next-door neighbor throws loud parties or if there’s a busy intersection close to your driveway.
Lack of sales and AVMs
If there aren’t any recent sales in your area, the tool might have trouble. It could also struggle when valuing unusual properties, or homes sold in a sparsely-populated area.
Because a tool has to return some value, even with limited data, it could spit out a number that’s wildly off.
Distressed properties and other sales skew data
Short sales and foreclosures can also skew data. While an agent or appraiser would drop a distressed sale out of analysis of comps — particularly if the home was in poor condition — an online tool can’t make this determination. And because distressed sales typically sell for less than the market value of a home in good condition, they could drag down the estimate of another home’s value.
It also can’t account for changes in title and deed that don’t relate to an open market sale. According to Ruiz, if someone just did their estate planning and transferred the title from their name to a trust, or passed it down to a child, they likely don’t put market value down on the forms. But the “sale” still goes into the AVM.
AVMs can’t account for personal factors
Personal factors come into play when determining a home’s value to you — like a short commute, or proximity to Grandma’s house. If you’re looking for a home office and find the perfect set up, that home could be worth more to you than one with no office space.
Algorithms and websites can’t account for personal taste and preferences which influence how you value a home.
Buying a home is a deeply personal decision, and you should have a person on your side to guide you through the process. While it’s fun to browse homes on websites, when it comes time to make an offer, reach out to an agent who can help you land on a price and budget that makes sense for your lifestyle.
Header Image Source: (Jenny Ueberberg / Unsplash)