The TAUREAN Residential Valuation System An Overview By Michael L. Robbins, Ph.D., CRE Taurean Residential Valuation Services, LLC 150 N. Sunny Slope Road, Suite 225, Brookfield, WI 53005 Phone: (262) 786-2512, Fax: (262) 784-7866 E-mail: mrobbins@taurean.com Introduction Real estate appraisals are generally used to estimate the market value (defined below) of a real property interest in real estate. Real estate appraisals are useful and necessary in many types of real estate transactions. However, a problem with real estate appraisal is that they require considerable effort and time to perform, are relatively expensive, difficult to review, and prone to error (it is not uncommon for three appraisers, independently appraising the same property, to be more than 20% apart in their final estimate of value). Typically, an appraiser is required to inspect the subject property to be appraised and determine the property s market value. The process of appraisal typically takes several days to finish, which may be too long in many of today s fast paced real estate transactions. In addition, the appraisal process does not provide much insight on how the comparable properties were selected, how the adjustment rates were determined, or most importantly how credible the analysis has been, all of which often results in estimates that do not support expected outcomes. Therefore, there is a need for a process that not only speeds up the appraisal production but also improves its overall quality. Market Value Defined: The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1 Buyer and seller are typically motivated; 2. Both parties are well informed or well advised, and acting in what they consider their own best interests; 3. A reasonable time is allowed for exposure in the open market; 4. Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and Taurean Residential Valuation Services July 19, 2001 Page 1
5. The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. The Appraisal of Real Estate, Tenth Edition, Appraisal Institute, 875 North Michigan Avenue, Chicago, Illinois 60611-1980, 1992, p.21. Automated Valuation Methods A Short History The use of computers in deriving value estimates has been an ongoing effort for several decades. A very early effort in supporting the professional appraisers use of automation can be traced back to an organization called EDUCARE (Educational Foundation for Computer Applications in Real Estate) located on the University of Wisconsin-Madison campus, beginning in early 1971. By the mid 1970 s the professional appraisal organizations had a project called the SREA Market Data Center, which collected and distributed comparable sale information and provided value estimates through the use of statistical methods such as multiple regression. Neither of these organizations survived past the early to mid 1980 s. Computing costs, limitations of data, and general lack of skill and knowledge by the user created barriers that could not be overcome. With the introduction of desktop computing, in the mid 1980 s, the environment changed rapidly. Local units of government began to automate much of their assessment procedures and found methods for distributing data. In addition, management technologies rapidly kept pace with the rapid evolution of desktop computing power. Data storage mediums, database management systems, statistical systems, and easy to utilize spreadsheet programs all combined to foster interest in developing automated tools to support the appraisal functions. Beginning in the mid 1990 s there was a flurry of activity in the development and implementation of a host of Automated Valuation Methods (AVMs). Driven by a combination of easing of some types of appraisal standards and the advent of the Internet and property record availability, AVMs have emerged in a variety of forms and levels of utility. In its most basic form, an AVM can utilize the Internet to access property records and assessed values. Many assessing districts across the nation have found it advantageous to provide Internet users direct access to property records and assessment information. These systems can be construed as AVMs. Beyond the systems provided by local assessment offices, individuals and corporations have invested time and money in developing a host of valuation methodologies. A unifying element of all of these systems is their focus on providing a value estimate for a subject property from data available in the public record. None of these systems takes into account the regulatory and business environment surrounding the estimation and reporting of market value by the professional appraiser. The TAUREAN system is the exception. It has been specifically designed and implemented to work within the regulatory and business environment of the professional appraiser. Taurean Residential Valuation Services July 19, 2001 Page 2
The primary failure of nearly all automated valuation methods (TAUREAN being the exception) is that they estimate the subject property s value by placing it, the subject, upon a internally derived statistical surface and then estimate the subject s value at its location on the statistical surface. This operation eliminates the unique characteristics of the subject and prevents the display of direct market evidence in support of the value estimate. Estimating the subject s value and then listing sales that have sold for approximately the estimated amount is not acceptable direct market evidence. It is a requirement that the appraiser provide direct market evidence, that is, the value estimate of the subject is derived directly from adjusting for differences between the subject and comparable transactions. An appraisal is an opinion of value. Although it is an impartial, expert, and reasoned conclusion formed by a trained professional based on an analysis of all relevant evidence, it is still an opinion. It represents the appraiser s perception of the most likely, most probable price available in an arm s-length transaction for the appraised interest subject to the qualifying conditions imposed. It is the intent of the TAUREAN System to assist the appraiser in their efforts, by efficiently managing the necessary clerical and mathematical operations of market value estimation, while permitting the appraiser to exercise professional skill and judgment. The Appraiser Dilemma` In other words: How to apply the rules of appraisal, for providing direct market evidence to support the market value conclusion, while at the same time meeting the demands of the client, underwriters, and various government service entities? For the appraiser who is truly attempting to perform in a professional manner, this is daunting task. For example, an appraiser is generally asked to judge what a property would bring if exposed to the market (provide an estimate of a property s market value). They must predict the outcome of a hypothetical event that has not yet occurred (i.e. the hypothetical sale of the property and the transaction process which would result). This is a short-term forecast that assumes immediate exposure to the market and as prompt a sale as current market conditions permit. Thus, the appraisal is an economic analysis under conditions of uncertainty and its findings can be expressed only in probabilistic terms. No appraisal process is capable of making a prediction of probable selling price in the form of a precise figure. However, the appraiser is confronted with the client demand to report the value conclusion as a single point estimate (and the problem is further complicated by the fact that the client most often provides the appraiser with the point value estimate they desire). The appraiser s business environment is further complicated by the simple fact that they are professionally liable for the market value conclusion rendered. If it can be shown that the appraiser performed in an unacceptable fashion and the performance resulted in harm to the client, the client can collect damages from the appraiser, generally from the appraiser s errors and omissions insurance carrier. Thus, the appraiser has a vested Taurean Residential Valuation Services July 19, 2001 Page 3
interest in utilizing tools that not only assist in meeting day-to-day business needs but also that help manage their business risk. Lastly, the valuation professional is further constrained by regulatory considerations that impact on the use of technology in valuation. Most importantly are the Uniform Standards of Professional Appraisal Practice (USPAP) guidelines relative to an appraiser s use of automated valuation methods. The TAUREAN System is structured to follow nearly all requirements of USPAP, including special advisory opinions, Data Demands The market value estimation of a specific subject property by a professional appraiser demands a highly specified attribute profile, one that is more highly specified than that generally utilized for tax assessment purposes. Tax assessment is faced with treating all properties equally, regardless of how unfairly. In addition, the assessor has considerable political concerns to deal with, such as neighbor-to-neighbor value comparisons and budget limitations. The appraiser is faced with providing an accurate, supportable, and believable market value estimate of what the subject property will likely sell for on a given day. The acceptability of the evidence supporting the value estimate is measured by the appraiser s confidence that the evidence utilized is capturing the dynamics of market behavior across multiple dimensions. It is well recognized that a buyer s offer price is conditioned by a wide array of elements of comparison, some of which exist within the boundary of the parcel and many others that exist outside the boundary of the parcel. The TAUREAN System s spatial integration of data is a direct extension toward meeting the appraiser s supportability needs. In determining the market value of a subject property, an appraiser generally considers three separate approaches to value: the Cost Approach, the Income Approach, and the Sales Comparison Approach. The TAUREAN System is specific to the Sales Comparison Approach. Sales Comparison Approach The sales comparison approach to value is premised on the economic principal of substitution. As applied in the sales comparison approach, the principle of substitution holds that the value of a property tends to be set by the price that would be paid to acquire a substitute property of similar utility and desirability within a reasonable amount of time. This principle implies that the reliability of the sales comparison approach is diminished if substitute properties are not available in the market. An important component of the TAUREAN System is to assist in overcoming the problem of diminished reliability by making available to the valuation professional efficient access to an increased number of substitute properties, inventoried with accurate and enriched property attributes. Taurean Residential Valuation Services July 19, 2001 Page 4
In real estate, the correct application of the sales comparison approach to value requires that the appraiser provide direct market evidence to answer two critical questions. The first question is What are the important attributes that the market is using when determining a bid price for a subject property? The simple fact that an attribute such as Number of Bedrooms is printed on a standard form does not mean that bedrooms are an important unit of comparison by the market. It is the appraiser s professional responsibility to determine which attributes are important to the market segment expected to bid on the subject property. The second critical question is How important is each of the important attributes? The professional appraiser is trained to apply a variety of techniques (from paired sales to inferential statistical analysis) to derive these measures of importance (adjustment rates). The fact that the underwriter for Client A will only accept a $1,500 adjustment for difference in bedrooms, while the underwriter for Client B will only accept a $2,500 adjustment for difference in bedrooms, within the very same neighborhood, greatly complicates the appraiser s reporting of their market value conclusion. The accuracy of an appraisal is measured by the appraiser s confidence in the correctness of the data, the calculations performed in the approach, and the adjustments made to the sale price of each comparable property. The TAUREAN System is uniquely positioned to assist in this complicated business environment. The process developed provides to the professional appraiser an enhanced database of property attributes designed to capture the behavior of market participants in their determination of price. From this enhanced attribute database, procedures are applied which directly answer the two critical questions of the sales comparison approach (what are the important attributes and how important are they), thus providing the necessary direct market evidence. Procedures are then applied to the market derived adjustment rates that make them more acceptable to the appraiser s clients, underwriters, and government service entities. To apply the sales comparison approach, an appraiser follows a systematic procedure. A general outline of the basic procedure follows. 1. Research the market to obtain information on sales transactions, listings, and offers to purchase or sell properties that are similar to the subject property in terms of characteristics, such as property type, date of sale, size, location, and zoning. The TAUREAN System provides for automatic primary filtering (with user override) for such attributes as property type, and zoning. The attribute rules database and any user specified secondary attribute filtering provide full functionally to specify value ranges for date of sale, size, location or any other attribute of interest. 2. Verify the information by confirming that the data obtained are factually accurate and that the transactions reflect arm s-length market considerations. Verification may also elicit additional information about the market. Taurean Residential Valuation Services July 19, 2001 Page 5
The TAUREAN System assists in testing whether attributes are factually accurate through its custom missing data analysis of all records prior to being made available for use. The test of a transaction s sale price being an arm slength transaction is accomplished through the sale condition analysis (see Figure 2). Finally, the elicitation of additional information is represented in TAUREAN s derivation of attributes such as average room size and lot coverage ratio. 3. Select relevant units of comparison and develop a comparative analysis for each unit. The unit of comparison for owner occupied residential property is the unit itself. While units such as price per room or price per square foot could be used, the market, and thus the analysis, would normally focus on the unit. 4. Compare comparable sale properties with the subject property using the elements of comparison and adjust the sale price of each comparable appropriately to the subject property or eliminate the sale property as a comparable. The TAUREAN System completes this task in several steps (See Figure 5): Comparable selection based on standardized similarity to subject. Comparable selection based on Euclidian Distance of aggregate standardized similarity. Calibration of adjustment rates to micro neighborhood of subject. Comparable selection based on Euclidian Distance of aggregate dollar amounts of adjustment. 5. Reconcile the various value indications produced from the analysis of comparables into a single value indication or a range of values. In an imprecise market subject to varying occupancies and economies, a range of values may be a better conclusion than a single value estimate. The TAUREAN System completes this task as follows: For the final comparables used for pricing (selected automatically or by the user), each selected comparable is ranked with Euclidian Distance and weighted with sum-of-digits (to emphasize the comparable most like the subject and de-emphasize the comparable least like the subject). The weighted value estimate is then rounded to the nearest $500 and identified as final value estimate. The results of the analysis are then reviewed for appraisal quality and the results reported to the user. Taurean Residential Valuation Services July 19, 2001 Page 6
The TAUREAN Residential Valuation System The TAUREAN Residential Valuation System (TRVS) is provided as an Internet based process for estimating the price of a subject property. The process comprises two separate and distinct functions. The first function is comprised of a series of operations that result in the creation of an enhanced and spatially integrated database of property attributes designed to support the appraiser s efforts in estimating market value (See Figures 1, 2, 3, 4). The second function is to utilize the Internet to allow the appraiser fast and easy access to the database to select a subject property, make any necessary inventory corrections to the subject property, apply analysis parameters to control and direct the selection of comparables, price the subject property (See Figure 5), quality review the resulting price estimate, create a report with maps, export the results to a forms generator for report packaging, combine all necessary report elements into a single document, and then print the document and all necessary maps and photographs. Conclusion The TAUREAN Residential Valuation System is designed such that the resulting value estimate is (1) reasonably accurate, unbiased, and a direct extension of prior market behavior. (2) Supportable by the professional appraiser through its design and implementation of the designated rules of appraisal. (3) Believable by the appraiser s clients due to its tie to direct market evidence that can be reviewed and checked. Taurean Residential Valuation Services July 19, 2001 Page 7
Figure - 1 External Data Management Geo Code Lot Characteristics Above Ground Surface Below Ground Improvements Inventory Neighborhood Social/Economic Land cover Land Use Location Point-to-point Buffer Zones Data Correction Enhanced Geo Coded of All Properties figure - 2 Derive Sale Condition Model Determine Sale Condition Breakpoints Specify Sale Condition Model Figure - 3 Derive Average Attribute Adjustment Rates Attribute Rules Figure - 4 Perform Final Calibration System Control System Ready Taurean Residential Valuation Services July 19, 2001 Page 8
Figure - 2 Derive Sale Condition Model Enhanced Geo Coded Parcel File Multiple Regression Statistical Analysis Program Derive Sale Condition Model Derive Sale Condition Breakpoints Specify Sale Condition Model Taurean Residential Valuation Services July 19, 2001 Page 9
Figure - 3 Derive Attribute Rules Enhanced Geo Coded Parcel File Multiple Regression Statistical Analysis Program Derive Average Attribute Adjustment Rates NO Management Specification YES Default Attribute Rules Custom Attribute Rules Taurean Residential Valuation Services July 19, 2001 Page 10
Figure - 4 Calibration Enhanced Geo Coded Parcel File Default Attribute Rules Default Control 500 Recent Sales Valuation Engine Sale Price Reasonable NO Remove From Further Consideration YES Determine Time Range Mean Error ~ 0 Determine Sale Condition Adjustment Rate Determine Sale Condition With Smallest Absolute Error Bracket Smallest Absolute Error Identify Sale Condition With Smallest Absolute Error & Produce Report Taurean Residential Valuation Services July 19, 2001 Page 11
Figure - 5 Price Subject Enhanced Select Transactions Determine Subset of Sales For valuation Attribute Rules Adjust Sale Price for Time Standardize Comparables and Subject System Control Determine Final Most Similar Sales Calibrate Attributes to Micro Neighborhood Price Subject Identify Profile with Best Quality Produce Quality Review Return Taurean Residential Valuation Services July 19, 2001 Page 12