Home » Archives for June 2019

Month: June 2019

AVM Regulatory Outlook

As always, changes are coming to the valuation industry. These changes have been germinating in government and industry for a long time, but they’ve made progress in the last year, and I believe that they’re likely to emerge sometime this year.  I expect that we may see more regulatory changes liberalizing the use of AVMs soon.

I think that you’ll come to that same conclusion, too, if I share a couple milestones that I’ve observed and put them together with some insights I’ve gathered from talking to industry leaders.

The first milestone I will highlight was the July 2018 Financial System report by Secretary Mnuchin, which is consistent with the administration’s new attitude towards regulation. The report is far-reaching, and it includes thoughtful commentary about the uses of AVMs (see, for example, page 103-106). It recommends updating FIRREA appraisal requirements to accommodate increased usage of AVMs and hybrids. It also advocates for increased monitoring of AVMs and the application of rigorous market standards. And, it recommends focusing the use of AVMs and hybrids on loan programs with other mitigating risk factors.

The next milestone I will highlight was the proposed change in the de minimis threshold that was put out for comment in November of last year. The change would raise the threshold below which a residential mortgage could be originated with an evaluation, utilizing an AVM in lieu of a traditional appraisal. It would be raised from $250,000 to $400,000.

To those milestones I would add a third data point.  Last November I attended the Appraisal Subcommittee roundtable entitled: “The Evolving Real Estate Valuation Landscape.” As part of the of the Federal Financial Institutions Examination Council, the roundtable brought together industry representatives and government officials (see the table below) to discuss real estate valuation.

The day was split into two sessions; the morning and afternoon sessions each began with a panel of industry experts who addressed a series of prepared questions. In addition, there was a roundtable discussion focused on quotes from the July 2018 Financial System report referenced above.

The topic for the morning discussion was “Harmonizing Real Estate Valuation Requirements Across the Federal Government.” This session focused on identifying various federal appraisal statutory and regulatory requirements and exploring opportunities to harmonize those requirements, e.g., VA, FHA, and FHFA all having differing valuation requirements and standards.

The afternoon panel discussion topic was; “The Evolution of Real Estate Valuation” which focused on evolving valuation needs in commercial and mortgage lending. A key area of this session was focused on Alternative Valuation Products inclusive of AVM’s and their increasing used by lenders and the secondary market.

The roundtable discussion started with quotes about AVMs and hybrid valuation products and focused on standards. The group also contemplated how alternative valuation techniques can impact quality and mitigate risk. Finally, one quote that focused on speeding the adoption of technology was discussed.

As I write this six months later, I see the pieces of the puzzle coming together. Obviously, there is momentum behind the increased usage of AVMs, for their independence, increasing accuracy, speed and efficiency. But there is also an implicit concern to avoid opening the door to more risk. I see this being expressed by talk about “standards,” alternative products, such as “hybrids” and increased monitoring.

As I have written elsewhere, I welcome changes that make better use of our valuable and limited resources, namely the appraisers themselves. As AVM quality improves and the number of appraisers shrinks, we should encourage appraisers to be focused on their highest and best use. Their expertise should be focused on the complex, qualitative aspects of property valuation such as the property condition and market and locational influences.  They should also be focused on performing complex valuation assignments in non-homogeneous markets. Trying to be a “manual AVM” is not the highest and best use of a highly qualified appraiser, and I expect that Treasury, the FDIC and legislators are moving in this same direction.

 

Lee Kennedy

 

Participants in “The Evolving Real Estate Valuation Landscape” Appraisal Subcommittee, Federal Financial Institutions Examination Council, 2018
Government Trade Organizations Industry Participants
The Appraisal Foundation (TAF) American Bankers Association AVMetrics, LLC
Association of Appraiser Regulatory Officials (AARO) American Society of Appraisers Bank of America
Consumer Financial Protection Bureau (4) American Society of Farm Managers and Rural Appraisers Clarocity Valuation Services
Federal Deposit Insurance Corporation(3) Appraisal Institute ClearBox
Federal Housing Finance Agency(4) Homeownership Preservation Foundation CoreLogic
Federal Reserve Board(5) Independent Community Bankers of America Cushman & Wakefield Global Services, Inc.
Freddie Mac Mortgage Bankers Association Farm Credit Mid-America
Internal Revenue Service National Association of Home Builders First American Mortgage Solutions
National Credit Union Administration National Association of Realtors Genworth Financial
Office of the Comptroller of the Currency (4) Real Estate Valuation Advocacy Association (REVAA) JPMorgan Chase & Company
Tennessee Real Estate Appraisers Commission State appraiser coalitions representative Old Line Bank
Texas Appraiser Licensing and Certification Board Quicken Loans
U.S. Department of Agriculture ServiceLink
U.S. Department of Justice (2)
U.S. Department of the Interior (2)
U.S. Department of Veterans Affairs
US. Department of Housing and Urban Development

 

The Proper Way to Select an AVM

After determining that a transaction or property is suitable for valuation by an Automated Valuation Model (AVM), the first decision one must make is “Which AVM to use?” There are many options – over 20 commercially available AVMs – significantly more than just a few years ago.  While cost and hit rate may be considerations, model accuracy is the ultimate goal. A few additional estimates that are off by more than 20 percent can seriously increase costs. Inaccuracy can increase second-looks, cause loans not to close at all or even stimulate defaults down the road.

Which is the best AVM?

We test the majority of residential models currently available, and in the nationwide test in Figure #1 below, Model AM-39 (not its real name) was the top of the heap. It has the lowest average (absolute) error (MAE) by .1 over the 2nd place model.  Model AM-39 is a full percentage point better than the 5th ranked model, which is good, but that’s not everything. Model AM-39 has the highest percentage of estimates within +/- 10% (PPE10%). Model AM-39 has the 2nd lowest percentage of extreme overvaluations (>=20%, or RT20 Rate), an especially bad type of error indicating a significant overvaluation or Right Tailed error.

Figure 1: National AVM Ranking

If you were shopping for an AVM, you might think that Model AM-39 is the obvious choice. This model performs at the top of the list in just about every measure, right? Well, not so fast. Consider that those measurements are based on testing AVM’s across the entire nation, and if you are only doing business in certain geographies, you might only care about which model or AVM is most accurate in those areas. Figure 2 shows a ranking of models in Nevada, and if your heart was set on Model AM-39, then you would be relieved to see that it is still in the top 5. And, in fact, it performs even better when limited to the State of Nevada. However, three models outperform Model AM-39, with Model X-24 leading the pack in accuracy (albeit with a lower Hit Rate).

Figure 2 Nevada AVM Rankings

So, now you might be sold on Model X-24, but you might still look a little deeper. If, for example, you were a credit union in Clark County, you might focus on performance there. While Clark County is pretty diverse, it’s quite different from most other counties in Nevada. In this case, Figure 3 shows that the best model is still, Model X-24, and it performs very well at avoiding extreme overvaluations.

Figure 3 Clark County AVM Rankings

However, if your Clark County Credit Union is focused on entry level home loans with properties values below $100K, you might want to check just that segment of the market. Figure 4 shows that Model X-24 continues to be the best performer in Clark County for this price tier. Note that the other top models, including Model AM-39, show significant weaknesses as their overvaluation tendency climbs into the teens. This is not a slight difference, and it could be important. Model AM-39 is seven times more likely than Model X-24 to overvalue a property by 20%, and those are high-risk errors.

Figure 4 Clark County AVM Rankings, <$100K Price Tier

Look carefully at the model results in Figure 4 and you’ll see that Model X-24, while being the most accurate and precise, has the lowest hit rate. That means that about 40% of the time, it does not return a value estimate. The implication is: you really want a second and a third AVM option.

 

Now let’s consider a different lending pattern for the Clark County credit union. Consider a high value property lending program and look at figure 5, which is an analysis of the over-$650K properties and how the models perform in that price tier. Figure 5 shows that Model X-24 is no longer in the top five models. The best performer in Clark County for this price tier is Model AM-39, with 92% within +/-10% and zero overvaluation error in excess of 20%. The other models in the top five also do a good job of valuing properties in this tier.

Figure 5 Clark County AVM Ranking, >$650K Price Tier

Figure 6 summarizes this exercise, which demonstrates the proper thinking when selecting models. First, focus on the market segment that you do business in – don’t use the model that performs best outside your service area. Second, rather than using a single model, you should use several models prioritized into what we call a “Model Preference Table®” in which models are ranked #1, #2, #3 for every segment of your market. Then, as you need to request an evaluation, the system should call the AVM in the #1 spot, and if it doesn’t get an answer, try the next model(s) if available.

Figure 6 Summary of AVM Rankings

In this way, you get the most competent model for the job. Even though one model will test better overall, it won’t be the best model everywhere and for every property type and price range.  In our example, the #1 model in the nation was not the preferred model in every market segment we focused on. If we had focused on another geography or market segment, we almost certainly would have seen a reordering of the rankings and possibly even different models showing up in the top 5. The next quarter’s results might be different as well, because all the models’ developers are constantly recalibrating their algorithms; inputs and conditions are changing, and no one can afford to stand still.