Tuesday, June 3, 2014

Pricing vs. Appraising a Property

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The introduction of the new HDB COV rules has sparked much public discussion about pricing homes versus appraising them.

In March, HDB moved its official valuation from before the Option-to-Purchase (OTP) to after it.  In explaining the change, National Development Minister Khaw Boon Wan said, "HDB will rationalise the process of price negotiations and restore the original intention of valuation, which is to help buyers get a housing loan. Negotiating based on price rather than COV will take some getting used to. However, it is a useful move for long-term market stability."


Since then, the public and industry professionals continue to debate what this rule change means to the market.  What will replace the HDB valuation in the negotiating process?  Will HDB valuations match the market price?  How can one estimate cash outlay?  What is the difference between pricing a property and appraising it?

The reason this debate is taking place is because the real estate market, particularly in the area of pricing, is fundamentally changing thanks to technology and big data.  The market’s solution of using valuations to price homes is being replaced by a computer overlaid by professional human judgment.

Traditionally, the process of establishing a price in real estate has been opaque, especially when compared with other financial assets like stocks and bonds.  In other words, there was no market clearing price in the real estate market that established an equilibrium price for like properties.

Market participants have tried to substitute valuations for market price but that is problematic for three reasons.  First, by definition, valuation does not equal market price. A valuation is an expert’s appraisal of the fundamental market value of a home.  Appraisers follow a strict methodology, based on the best market data available, to arrive at a financial assessment of the home.  Valuations cannot take into account the human element that impacts the final transacted price.  Only a negotiation between the buyer and the seller can factor in the human considerations that make it possible to agree on the transacted price, which, by definition, then becomes the market price for the particular home.

The second reason valuations cannot act as a market clearing price is because they are non-standard in that two different appraisers can arrive at a different valuation based on the same set of data.  Further complicating the matter is that the valuer may not have access to the best data available or have the capacity to process data from tens of sources without the use of technology.

Finally, there is no mechanism to harness non-standard appraisals conducted by different valuation firms in a way that allows real estate agents and consumers to use valuations as a starting point for assessing the market price.  In other words, valuations are not universally available to the entire market.

For these three reasons, a valuation is a poor substitute for pricing a home to buy or sell.

Don’t get me wrong.  Valuations will continue to play a very important role in real estate, but they will do so in the areas that, as Minister Khaw implied, they are best equipped to support.  For example, valuations are critical to the work of bankers, accountants, real estate institutions, and other parties in need of expert judgment.

Going forward, technology and big data are helping to move real estate to the sort of market clearing price that is found in the stock and bond markets.  Technology is better suited to do this than individual valuations because a computer can instantaneously cross-reference thousands of records from multiple data sources through best practices methodologies and disseminate a single estimated market value, which we call the X-Value, to professionals and the public.

The X-Value can then be used by consumers and their agents as a starting point for pricing a property and, in addition, estimating cash outlay.  They can review the similar transactions and methodology-driven adjustments that went into deriving the X-Value.

Some critics of computer-generated market estimates argue that a computer cannot deal with the exceptions.  For example, they argue, only a human can access the value of a unique bungalow that has no comparable.  This may be true in certain cases, but it is missing the point of information and technology.

The purpose of technology like X-Value is not to dictate the market price.  As mentioned, only the negotiation process, by humans, can arrive at the transacted price, and, thus, the market price.  The role of technology is to collect and display the best available data so that professional agents can support their clients in finding the right home at the right price.

The Parliament created the Estate Agents Act of 2010 in response, in part, to miselling in the real estate market.  One notorious case occurred precisely because the aggrieved party did not have access to transparent pricing.  To the credit of the real estate industry, leading estate agencies have used SRX’s technology platform to introduce more timely and comprehensive pricing information to assist people in pricing homes.  Technology means that this information is ubiquitous and can serve as a starting point for pricing a home, which in turn provides more stability to the market and acts as a better substitute than valuations as a market clearing price mechanism.

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