AVMetics’ ongoing independent AVM testing continues in 2023 according to the schedule in the link below (updated as of January 3, 2023). Please download the pdf with the revised 2023 testing schedule.
Four Points to Consider Before Outsourcing AVM Validation
AVMs are not only fairly accurate, they are also affordable and easy to use. Unfortunately, using them in a “compliant” fashion is not as easy. Regulatory Bulletins OCC 2010-42 and OCC 2011-12 describe a lot of requirements that can be challenging for a regional or community institution:
- ongoing independent testing and validation and documentation of testing;
- understanding each AVM model’s conceptual and methodological soundness;
- documenting policies and procedures that define how to use AVMs and when not to use AVMs;
- establishing targets for accuracy and tolerances for acceptable discrepancies.
The extent to which these requirements are applied by your regulator is most likely proportional to the extent to which AVMs are used within your organization; if AVMs are used extensively, regulatory oversight will likely demand much tighter adherence to the requirements as well as much more comprehensive policies and procedures.
Although compliance itself is not a function that can be outsourced (it is the sole responsibility of the institution), elements of the regulatory requirements can be effectively handled outside the organization through outsourcing. As an example, the first bullet point, “ongoing independent testing and validation and documentation of testing,” requires resources with the competencies and influences to effectively challenge AVM models. In addition, the “independent” aspect is challenging to accomplish unless a separate department within the institution is established that does not report up through the product and/or procurement verticals (e.g. similar to Audit, or Model Risk Management, etc.). Whether your institution is a heavy AVM user or not, the good news is that finding the right third-party to outsource to will facilitate all of the bullet points above:
- documentation is included as part of an independent testing and validation process and it can be incorporated into your policies and procedures;
- the results of the testing will help you shape your understanding of where and when AVMs can and cannot be used;
- the results of the testing will inform your decisions regarding the accuracy and performance thresholds that fit within your institution’s risk appetite. In addition,
- an outsourced specialist may also be able to provide various levels of consultation assistance in areas where you may not have the internal expertise.
Before deciding whether outsourcing makes sense for you, here are some potential considerations. If you can answer “no” to all of these questions, then outsourcing might be a good option, especially if you don’t have an independent Analytics unit in-house that has the resource bandwidth to accommodate the AVM testing and validation processes:
- Is this process strategically critical? I.e., does your validation of AVMs benefit you competitively in a tangible way?
- If your validation of AVMs is inadequate, can this substantially affect your reputation or your position within the marketplace?
- Is outsourcing impractical for any reason? I.e., are there other business functions that preclude separating the validation process?
- Does your institution have the same data availability and economies of scale as a specialist?
The Way Forward
Here are some suggestions on how to go about preparing yourself for selecting your outsource partner:
- Specify what you need outsourced. If you already have Policies and Procedures documented and processes in place, there may be no need to look for that capability, but there will necessarily still be the need to incorporate any testing and validation results into your existing policies and procedures. If you have previously done extensive evaluations of the AVMs that you use, in terms of their models’ conceptual soundness and outcomes analysis, there’s no need to contract for that, either. See our article on Regulatory Oversight to get some ideas about those requirements.
- Identify possible partners, such as AVMetrics, and evaluate their fit. Here’s what to look for:
- Expertise. It’s a technical job, requiring a fair amount of analysis and a tremendous amount of knowledge about regulatory requirements in general, and specifically knowledge relative to AVMs; check the résumés of the experts with whom you plan to partner.
- Independence. A vendor who also sells, builds, resells, uses or advocates for certain AVMs may be biased (or may appear to be biased) in auditing them; validation must be able to “effectively challenge” the models being tested.
- Track record. Stable partners are better, and a long term relationship lowers the cost of outsourcing; so look for a partner with a successful track record in performing AVM validations.
- Open up conversations with potential partners early because the process can take months, particularly if policies and procedures need to be developed; although validations can be successfully completed in a matter of days, that is not the norm.
- Make sure your staff has enough familiarity with the regulatory requirements so as to be able to oversee the vendor’s work; remember that the responsibility for compliance is ultimately on you. Make sure the vendor’s process and results are clearly and comprehensively documented and then ensure that Internal Audit and Compliance are part of that oversight. “Outsource” doesn’t mean “forget about it;” thorough and complete understanding and documentation is part of the requirements.
- Have a plan for ongoing compliance, whether it is to transition to internal resources or to retain vendors indefinitely. Set expectations for the frequency of the validation process, which regulations require to be at least annually or more often, commensurate with the extent of your AVM usage.
AVM testing and validation is only one component in your overall Valuation and evaluation program. Unlike Appraisals and some other forms of collateral valuation, AVMs, by their nature as a quantitative predictive model, lend themselves to just the type of statistically-based outcomes analysis the regulators set forth. Recognizing this, elements of the requirements can be an outsourced process, but it must be a compliment to enterprise-wide policies and practices around the permissible, safe and prudent use of valuation tools and technologies.
The process of validating and documenting AVMs may seem daunting at first, but for the past 10 years AVMetrics has been providing ease-of-mind for our customers, whether as the sole source of an outsourced testing and validation process (that tests every commercial AVM four times a year), or as a partner in transitioning the process in-house. Our experience, professional resources and depth of data have enabled us to standardize much of the processing while still providing the customization every institution needs. And probably one of the most critical boxes you can check off when outsourcing with AVMetrics is the very large one that requires independence. It also bears mentioning that having been around as long as we have, our customers have generally all been through at least one round of regulatory scrutiny, and the AVMetrics process has always passed regulatory muster. Regulatory reviews already present enough of a challenge, so having a partner with established credentials is critical for a smooth process.
2020 Testing Schedule Announced
AVMetics’ ongoing independent AVM testing continues in 2020 according to the schedule in the link below. Please download the pdf with the entire 2020 testing schedule.
An Interview with Lee Kennedy: Trends, the Future, and Regulation
The AVMNews sat down with our publisher Lee Kennedy to discuss trends in the industry.
AVMNews: Lee, as the Managing Director at AVMetrics, you’re sitting at the center of the Automated Valuation Model (AVM) industry. What changes have you seen recently?
Lee: There’s a lot going on. We see firsthand how the evolution of the technology has affected the sector dramatically. The availability of data and the decline in costs of storage and computing power have opened the doors to new competition. We see new entrants using new techniques and built by fresh faces. We still have a number of large players offering well-established AVMs. But, we also see the larger players retiring some of their older models. The established AVM players have responded in some cases by raising their game, and in other cases, by buying their upstart rivals. So, we’ve seen increased competition and increased consolidation at the same time.
And, it’s true that the tools keep getting better. It’s not evenly distributed, but on average they continue to do a better and better job.
AVMNews: In what ways do AVMs continue to get better?
Lee: AVMetrics has been conducting contemporaneous AVM testing for over a decade now, and we have many quantitative metrics showing how much better AVMs are getting. Specifically, we run statistical analysis around the comparison of AVM estimates to sales prices that are unknown to the models. We have seen increases in model accuracy rates measured by percentage of predicted error (PPE), mean absolute error (MAE) and a host of other metrics. Models are getting better at predicting sale prices and when they miss, they don’t miss by as much as they used to.
AVMNews: What about on the regulatory side?
Lee: There is always a lot going on. The regulatory environment has eased in the last two years reflecting a whole new attitude in Washington, D.C. – one that is more open to input and more interested in streamlining. Take, for instance, the 2018 Treasury report that focuses on advancing technologies (See “A Financial System That Creates Economic Opportunities”).
Last November, I was at a key stakeholder forum for the Appraisal Subcommittee (ASC). One area of focus was harmonizing appraisal requirements across agencies. Another major focus was how to effectively employ new tools in support of the appraisal industry, including the growth of Alternative Valuation Products that utilize AVMs.
AVMNews: I know that you also wrote a letter to the Federal Finance Institutions Examination Council (FFIEC) about raising the de minimis threshold, below which some lending guidelines would NOT require an appraisal. This year in July they elected to change the de minimus threshold from $250,000 to $400,000 for residential housing. What are your thoughts?
Lee: Well, I think that the question everyone is struggling with is “What does the future hold for appraisers and AVMs?” Obviously, the field of appraisers is shrinking, and AVMs are economical, faster and improving. How is this going to play out?
First, my strong feeling is that appraisers are a valuable and limited resource, and we need to employ them at their highest and best use. Trying to be a “manual AVM” is not their highest and best use. Their expertise should be focused on the qualitative aspects of the valuation process such as condition, market and locational influences, not the quantitative (facts) such as bed and bath counts. Models do not capture and analyze the qualitative aspects of a property very well.
Several companies are developing ways of merging the robust data processing capabilities of an AVM with the qualitative assessment skills of appraisers. Today, these products typically use an AVM at their core and then satisfy additional FFIEC evaluation criteria (physical property condition, market and location influences) with an additional service. For example, the lender can wrap a Property Condition Report (PCR) around the AVM and reconcile that data in support of a Home Equity Line of Credit (HELOC) lending decision. This type of hybrid product offering is on the track that we’re headed down. Many AMCs and software developers have already created these types of products for proprietary use or for use on multiple platforms.
AVMNews: AVMs were supposed to take over the world. Can you tell us what happened?
Lee: Well, the Financial Crisis is one thing that happened. Lawsuits ensued, and everyone got a lot more conservative. And, the success of AVMs developed into hype that was obviously unrealistic. But, AVMs are starting to gain traction again. We are answering a lot more calls from lenders who want help implementing AVMs in their origination processes. They typically need our help with policies and procedures to stay on the right side of the Office of the Comptroller of the Currency (OCC) regulations, and so in the last year, we’ve done training at several banks.
Everyone is quick to point out that AVMs are not infallible, but AVMs are pretty incredible tools when you consider their speed, accuracy, cost and scalability. And, they are getting more impressive. Behind the curtain the models are using neural networks and machine learning algorithms. Some use creative techniques to adjust prices conditionally in response to situational or temporary conditions. We test them and talk to their developers, and we can see how that creativity translates into improved performance.
AVMNews: You consult to litigants about the use of AVMs in lawsuits. How do you think legal decisions and risk will affect the use of AVMs?
Lee: This is an area of our business, litigation support, where I am restricted from saying very much. It has been and continues to be an enlightening experience as some of the best minds are involved in all aspects of collateral valuation and the “Experts” are truly that… experts in their fields as econometricians, statisticians, appraisers, modelers, etc.… It is also very interesting with over 50 cases behind us now, to get a look behind the legal system curtain and how all of that works. Therefore, I want to emphasize that my comments for our interview are in the context of contemporaneous AVMs that were tested during the time period shown here and not a retrospective AVM that was looking back to these time periods.
AVMNews: AVMetrics now publishes the AVM News – how did that come about?
Lee: As you and the many subscribers know, Perry Minus of Wells Fargo started that publication as a labor of love over a decade ago. When he retired recently, he asked if I would take over as the publisher. We were honored to be trusted with his creation, and we see it as a way to be good citizens and contribute to the industry as a whole.
AVMNews: I encourage anyone interested in receiving the quarterly newsletter for free to go to http://eepurl.com/cni8Db
The AVMNews is a quarterly newsletter that is a compilation of interesting and noteworthy articles, news items and press releases that are relevant to the AVM industry. Published by AVMetrics, the AVMNews endeavors to educate the industry and share knowledge about Automated Valuation Models for the betterment of everyone involved.
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.
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).
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.
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.
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 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.
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.
2019 Testing Schedule Announced
AVMetics’ ongoing independent AVM testing continues in 2019 according to the attached schedule. Please use the link below to download a pdf with the entire 2019 testing schedule.
The Wild, Wild West of Automated Valuations
Recently the OCC, FDIC and the Federal Reserve proposed raising the de minimis threshold for residential properties below which appraisals are not required to complete a home loan. Currently, most homes transacting at $250K and above require an appraisal, but Federal regulators propose to raise that level to $400K. A November 30th Wall Street Journal article raises some interesting issues about the topic. They reported that the number of appraisers is down 21% since the housing crisis, but more homes require an appraiser, since more and more homes exceed the threshold each year. The article also states that these factors open the door for cheaper, faster and “largely untested” property valuations based on computer algorithms, also known as Automated Valuation Models (AVMS).
At AVMetrics, we have been continuously testing AVMs for over 15 years, so we’ve seen how they’ve performed over time. As an example, the accompanying chart shows model performance accuracy as measured by mean absolute error, a statistical metric of valuation error. We utilize many statistical measures of evaluating model accuracy and precision, and they all show significant improvement in AVMs over time. And, as these automated tools get better and the workforce of appraisers continues to shrink, the FFIEC members’ proposed change seems warranted, but that doesn’t mean they don’t have their critics.
Ratish Bansal of Appraisal Inc was quoted in The Journal describing the state of AVMs as “a wild, wild West,” inviting, “abuse of all kind.” Furthermore, he contrasts that with the voluminous regulatory standards covering the use of appraisals.
We note much of those voluminous standards represent nearly the same quality control that was in place before the Credit Crisis. In other words, appraisals are not a guarantee against collateral risk. They are simply one tool in the toolbox – an effective, but comparatively time consuming and expensive tool. Also of note, far from being the “wild, wild west,” AVMs are also governed by regulators, most notably, Appendix B of the Appraisal and Evaluation Guidelines (OOC 2010-42) and Model Risk Management guidance (OCC 2011-12). These regulatory guidelines require that AVM developers be qualified, users of AVMs use robust controls, incentives be appropriate, and models be tested regularly and thoroughly with out-of-sample benchmarks. They require documentation of risk assessments and stipulate that a Board of Directors must oversee the use of all models. In other words, if AVMs were the “the wild, wild west” they would be rooted in a town with oversight of the legendary Wyatt Earp.
My strong feeling is that appraisals should not be a sole and exclusive tool when evaluations can be effectively employed in appropriate, lower-risk scenarios. Appraisers are a valuable and limited resource, and they should be employed at (to use appraisal terminology) their highest and best use. Trying to be a “manual AVM” is not the highest and best use of a highly qualified appraiser. Their expertise should be focused on the 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. AVMs do not capture and analyze the qualitative aspects of a property very well, and they still stumble in markets with highly diverse house stock or houses with less quantifiable attributes such as view properties.
However, several companies are developing ways of merging the robust data processing capabilities of an AVM with the qualitative assessment skills of appraisers. Today, these products typically use an AVM at their core and then satisfy additionally required evaluation criteria (physical property condition, market and location influences) with an additional service. For example, a lender can wrap a Property Condition Report (PCR) around the AVM and reconcile that data in support of a lending decision. This type of “Hybrid valuation” is on the track we’re headed down. Many companies have already created these types of products for commercial and proprietary use.
We at AVMetrics believe in using the right tool for the job, and we believe there is a place for automated valuations in prudent lending practices. We think the smarter approach would be to marginally raise the de minimis threshold, but simultaneously to provide additional guidance for considering other aspects of a lending decision, specifically, collateral considerations and eligibility criteria for appraisal exemptions such neighborhood homogeneity, property conformity, market conditions and more.
2018 Testing Schedule Announced
AVMetics’ ongoing independent AVM testing continues in 2018 according to the attached schedule. Please use the link below to download a pdf with the entire 2018 testing schedule.
How AVMetrics Tests AVMs
Testing an AVM’s accuracy can actually be quite tricky. It is easy to get an AVM estimate of value, and you can certainly accept that a fair sale on the open market is the benchmark against which to compare the AVM estimate, but that is really just the starting point.
There are four keys to fair and effective AVM testing, and applying all four can be challenging for many organizations.
- Your raw data must be cleaned up, to ensure that there aren’t any “unusable” or “discrepant” characters in the data; differences such as “No.” “#” and “Num,” must be normalized.
- Once your test data is “scrubbed clean” it must be assembled in a universal format and it must be large enough to provide reliable test results, even down to the segment level for each property type within each price level within each county, etc. and this might require hundreds of thousands of records.
- Timing must be managed so that each model receives the same sample data at the same time with the same response deadline.
- Last, and most difficult, the benchmark sales data must not be available to the models being tested. In other words, if the model has access to the very recent sales price, it will be able to provide a near-perfect estimate by simply estimating that the value hasn’t changed (or changed very little) in the days or weeks since the sale.
AVMetrics tests every commercially available AVM continuously and aggregates this testing into a report quarterly; AVMetrics’ testing process meets these criteria and many more, providing a truly objective measure of AVM performance.
The process starts with the identification of an appropriate sample of properties for which benchmark values have very recently been established. These are the actual sales prices for arm’s-length transactions between willing buyers and sellers—the best and most reliable indicator of market value. To properly conduct a “blind” test, these benchmark values must be unavailable or “unknown” to the vendors testing their model(s). AVMetrics provides in excess of a half million test records annually to AVM vendors (without information as to their benchmark values). The AVM vendors receive the records simultaneously, run these properties through their model(s) and return the predicted value of each property within 48 hours, along with a number of other model-specific outputs. These outputs are received by AVMetrics, where the results are evaluated against the benchmark values. A number of controls are used to ensure fairness, including the following:
- ensuring that each AVM vendor receives the exact same property list (so no model has any advantage)
- ensuring that each AVM is given the exact same parameters (since many allow input parameters that can affect the final valuation)
- ensuring through multiple checks that no model had access the recent sale data, which would provide an unfair advantage
In addition to quantitative testing, AVMetrics circulates a comprehensive vendor questionnaire twice annually. Vendors that wish to participate in the testing process complete, for each model being tested, roughly 100 parameter, data, methodology, staffing and internal testing questions. These enable AVMetrics, and more importantly our clients, to understand model differences within both testing and production contexts, and it enables us and our clients to satisfy certain regulatory requirements describing the evaluation and selection of models (see OCC 2010-42).
AVMetrics next performs a variety of statistical analyses on the results, breaking down each individual market, each price range, and each property type, and develops results which characterize each model’s success in terms of precision, usability and accuracy. AVMetrics analyzes trends at the global, market and individual model levels, identifying where there are strengths and weaknesses, and improvements or declines in performance.
The last step in the process is for AVMetrics to provide an anonymized comprehensive comparative analysis for each model vendor, showing where their models stack up against all of the models in the test; this invaluable information facilitates the continuous improvement of each vendor’s model offerings.
2017 Test File Schedule
We are pleased to share our 2017 testing schedule for our ongoing independent AVM testing. Please click the link below to download a pdf with the entire 2017 testing schedule.