Automated valuation models (AVM) like Zillow's (NASDAQ: ZG) (NASDAQ: Z) Zestimate have provided access and ease for estimating real estate values to millions of everyday Americans. Driven by data and algorithms, AVM technology is able to quickly and automatically provide estimated property values using property-specific and sales data.
While this model has been extremely popular, it hasn't always been accurate. But that could be changing. Zillow recently announced major changes to its valuation algorithm, leveraging neural networks to improve the error rate by nearly a whole percentage point.
Mimicking the brain to improve results
Neural networks are the latest approach backing machine learning, which allows Zillow's system to gather and link data like home facts, sales data, and housing trends from the property tax collector, property appraiser, and other data sources to formulate a valuation. The neural network mimics the neural pathways of our brain, which can access thousands to millions of data points and quickly draw logical conclusions based on this data.
This enhanced valuation system means the Zestimate can react and adapt more quickly to changes in the market and make more logical conclusions from the data it's gathering, reducing error rates and ultimately becoming more accurate.
How this impacts investors
More reactive, accurate valuations are great for creating leads to its website and trust in Zillow's brand and services but can cause complications for everyday investors. Zillow is using a wide variety of sales data, which takes hard factors into consideration like property location, size, age, and construction type, but the algorithm isn't able to determine the likely sales price based on an unknown condition. Renovated properties or homes that have been adequately updated and maintained over the homeowner's lifetime will sell for more than ones that have been neglected or are outdated.
Many investors target distressed properties that offer value-add opportunity, which often translates to a lower sales price. Inflated home values based on all property conditions rather than only similarly distressed properties could make a discounted purchase price a harder sell to homeowners seeking cash offers. It can, however, provide a faster, more accurate estimate for after repair value (ARV) for investors seeking to evaluate a property's potential sale price quickly during due diligence or negotiations.
It also means investors could face increasing competition with iBuyers like Zillow. More accurate valuations will give the company confidence to increase its iBuying activity, and now that a Zestimate has been turned into an instant cash offer, it can be hard for investors to beat the AVM's pricing.
The Millionacres bottom line
Ultimately, Zestimate is a helpful tool for homeowners and investors, but being able to understand its strengths and weaknesses and convey that to a potential seller is the key to its success in the investment world.