Computer Generated Residential Real Estate Appraisals, Have They Failed?
My appraising career started in 1996 and in the early 2000’s, as a young appraiser full of drive and enthusiasm, the rumbling from large lender’s was beginning to reflect the possibility of replacing physical appraisers and appraisals with AI (artificial intelligence) generated valuations. FANNIE MAE & FREDDIE MAC implemented the UAD appraisal (Uniform Appraisal Dataset) in 2010 as an attempt to get more of a standardization for residential home appraisals making appraisal reports easier to read and interpret, along with gathering data on every lender required appraisal performed. This large database of information at the time was going to be able to also assist AI appraisals by providing the algorithm with all the information collected from the physical appraisal inspections by state licensed / certified appraisers.
This was 12 years ago, and over the past three to four years, big investment firms have also attempted to use AI algorithms to do immediate valuations for decisions regarding value of real property residential property. At this time, the rumbling from the large lender’s was getting loud and appraisers were considered a “hinderance” in the loan funding process, not to mention, an additional cost to the consumers, as their AI could value the property on a “risk” analysis basis for a lower cost and an increase in speed. Companies like Zillow, Open Door, Offerpad, etc. were all using AI to make purchasing decisions to accumulate residential home portfolios, oftentimes creating false shortages of available homes on the market as purchased homes would remain vacant to create a shortage while watching the home value increase. All this seemed great, property values were skyrocketing (partially due to the fake shortage) across the Phoenix metro area and the entire country. Unfortunately, this led to first time buyers and the typical home buyers having to pay well above market value for their home. But wait, oftentimes FANNIE / FREDDIE were allowing appraisal waivers (they already had their AI model in place with all the condition / square footage / quality ratings accumulated over the past 10 plus years from actual appraisers for their database), so why not, they are willing to assume the risk, why does a consumer have to pay for a $500 appraisal in the scheme of the process. I mean, FANNIE and FREDDIE implemented desktop appraisals, real appraisers would just sit in their office and rely on hand selected photos and measurements from others to value the house. This is a great idea, right? Not for the consumer, but for the real estate machine, now they can fast tract a sale (even if the consumer is paying well above market value) an extra week or so, and the machine can earn their fees / commissions. FYI, the commission on just a $500,000 home on the low side for a realtor is $25,000 (sure they often split that with another agent, so maybe only $12,500 each on the low side). Lender’s commission can vary from 1.5% to 3.5%, so to be on the low side let’s say $10,000, title fees vary but average approximately 1% ($5,000). An appraisal fee is $500-$600 for a typical home in a typical neighborhood (approximately 1/10 of 1%, appraisal fees are not based on home values but on complexity / time required for completion).
Fast forward to late 2022, large real estate investment companies that have relied on AI for their valuation purchasing decisions are all either out of business and/or suffer large losses reflected in their stock prices (this was happing as early as May of 2022). Now, as an appraisal company, we are seeing market dumps of real estate investment companies losing as much as 10-20% on their purchases just a few months ago. How did or does this hurt the everyday consumer? Well, these investment companies were artificially driving up prices using their AI algorithms and assuming the risk based on artificially increasing property values. Now, property values would have increased regardless, it is just the level at which it increased and the speed of that increase. The normal supply and demand curve was damaged which resulted in an excessive shortage. The consumers that had to or needed to purchase their home during this time suffered from having to compete with these companies, and oftentimes not even getting an appraisal to make an informed decision on their purchase.
Disclosure, I am an appraiser and an owner of an appraisal company, so has this hurt us as a company? The answer is difficult to answer, as we were busy during this time and have maintained our office staff during this downturn over the past six months. Residential real estate is as individual as humans, every home has its pros and cons, positives and negatives, unique characteristics, etc. Having a professional appraiser perform an appraisal on your home not only gives you information that is non-biased, not compensated on if the home closes or not, it is truly one of only a few processes in the home purchasing process that are not dependent on the purchase price of the home and/or if the home closes, only to report the property and to give an opinion of market value based on the similar sales / listings / pending sales in that specific neighborhood. In addition, the appraiser will measure the property to calculate the true livable square footage, garage square footage, provide the correct site size, and note any marketability issues the property may have (home inspectors / termite inspectors are also critical cogs in the machine that also are there to provide the lender and/or potential purchaser information to make an informed decision).
So, in conclusion, I do believe the AI model has failed, as the proof is in the pudding. I also do believe that AI has a place in the loan approval / purchasing market. It is a checks and balances on an actual opinion of market value provided by a professional, and although AI values are often way out of bounds either high or low on certain properties, they can provide valuable statistics for risk analysis. Due to the unique characteristics of every home and the differing locations (even when in the same community), differing levels of condition, upgrades, square footage, layout, etc. every home should have an appraisal so the buyer can have a non-biased opinion of market value of that individual home. History has proven over the past 26 years of my career, that Macro valuations (AI appraisals) are only useful for a range of value or a large tolerance in financial risk, while Micro valuations (individual appraisals) are useful for the individual home (Subject property).
Additional Thoughts
FANNIE MAE & FREDDIE MAC have implemented some rules and guidelines that have been beneficial to the physical appraiser, including the UAD data set to keep some conformity when reporting a property along with the recent ANSI measuring guidelines (which I have personally always wanted as a standard to protect the consumer). Appraisal waivers along with desktop appraisals, are (in our opinion) a negative in consumer protection, but as a consumer you can always request a physical appraisal from an actual state Certified appraiser for peace of mind and a thoughtfully reconciled opinion of current market value to make informed financial decisions.