Thursday, May 30, 2019

Homequant Offers QA/Review AVM for SFR to 4-Family Homes

AVM is a Market Solution, Comparable Sales Analysis isn't (2 of 2)

    - Intended for New Analysts and Researchers -

If you provide a subject and a sales population to a group of concerned parties - an Assessor to a Bank Appraiser to a Listing Agent offering buyback guarantee to a traditional Listing Agent to a Buyer's Agent to an Appeals Consultant - you will be unpleasantly surprised by the outcome. They will pick different sets of comps based on their professional requirements and objectives, leading to different, often very conflicting, valuations. For instance, your Assessor may not have your best interest at heart as s/he has to meet a budgetary requirement, paving the way for counterparties like Appeals Consultants. A Listing Agent looking to get an "exclusive" may not do well with a set of middle-of-the-road comps which a Buyer's Agent might be interested in.  

In other words, the selection of comps is a function of the hat the party wears, making the entire process highly subjective. AVM, on the other hand (as I explained before - post 1 of 2) is a fairly scientific exercise. All variables interact with one another in an econometric equation and produce the resulting values. Therefore, all other factors remaining constant, two identical homes will have identical values - but not so in the world of the comparable sales analysis ("comp sales") as it is very party-specific.
Once the pool of sales, that closely represents the subject are properly scored and quantitatively adjusted, becomes comps. Generally, five best comps are then selected to value a subject. Valuers tend to use one of the three common methods - distance, least adjustments and sales recency - to narrow their choices down to the five contributing comps. Please read my prior postings (links below) for more details.   

In this analysis, the attributes of the subject home are: Bldg SF=3,250, Lot SF=17,400 and Bldg Age=26. 

From a large sales population, an optimal pool of 10 comps was algorithmically produced to demonstrate how subjectivity plays a key role in this valuation process. In each approach, the lowest ($308,770) and the highest value ($422,175) comps were removed. 

The above table represents the distance method, meaning the five closest (to the subject) comps were considered to be the best comps, producing a value range of $344,820 to $414,940, with a probable subject value of $388,775. Since least adjustments and recency of sales were ignored here, obviously several comps needing large adjustments or of older originations managed to creep in, thus making the process sub-optimal.  

The above table (middle one) represents the least adjustment method, meaning the comps that required the least adjustments were the best comps. The least adjustment is nothing but a balancing act. In other words, larger lots are compensated in value by smaller building sizes, lesser time adjustments are proxying for older homes, etc. For example, the second least adjusted comp (# 6) with much smaller lot was corrected by the larger and older building. It also sacrificed one of the closest (# 8) comps. This method produced a lower subject value of $371,150.

The above table (bottom one) represents the sales recency method, meaning the most recent five comps (in terms of sale dates) are the best ones. This is where the lowest and the highest value comps showed up on the initial line-up, hence substituted with the ones waiting in line. Though this method produced the most compact value range (upper bound was compacted down), it produced the lowest subject value of $360,340.

When analytics are robotized, this is how the game would be played out (no negotiations with robots until AI 5.0):

1. Assessor and Listing Agent (traditional) will be given the "distance" value.

2. Bank Appraiser and Listing Agent (buyback) will be given the "least adjustment" value.
3. Appeals Consultant and Buyer's Agent will be given the "sales recency" value.

Way to go, Mr. Robot.     

How to Reduce Subjectivity in Comp Sales

1. Apply meaningful selection, scoring/ranking and adjustments to the sales population

2. Build an AVM and insist on two AVM values (4th and 5th) on each line-up
3. Verify all comps spatially, ensuring they all come from same/compatible neighborhoods
4. Apply time adjustments in line with the local market (do not use national figures)
5. Pay attention to valuation dates (01-01-18 vs 08-16-18 require different adjustments)
6. While using sales recency, contract dates are preferred to closing dates (despite norm)
7. If you are not allowed to use AVM values, show them below the grid with value analysis
8. If the sales population is large, extract sample from the most recent arms-length sales
9. If the subject population is large, automate the process with batching technology.

Good Luck!

Sid Som, MBA, MIM

President, Homequant, Inc.

Link to Part-1
AVM is a Market Solution, Comparable Sales Analysis isn't (1 of 2)

AVM is a Market Solution, Comparable Sales Analysis isn't (1 of 2)

-- Intended for New Analysts and Researchers --

(Click on the image to enlarge)

The same sales population - derived from a single Zip Code - has been used across all three graphs (you may use other fixed locations like Census Tract, School District, etc.). Considering all sales from the same Zip, it helped minimize the impact of location (of course, you can never make location totally irrelevant as each block has a different appeal).

The above graph shows the noisy relationship between the uncorrected (raw) Sale Price and Bldg Size (Heated Living Area). The reason is very simple: Each sale is directly related to a buyer's judgment, hence is highly subjective. For instance, buyers are paying between $100K and $250K for a 1,500 SF home. While the investors would target the lower end of the range, the informed buyers would be in the middle and the uninformed buyers (someone who is bent on buying a pink house!) would succumb to the higher end of the range. The R-squared is therefore extremely low (0.189), explaining very little of the variations in sale prices.  

The Regression Value-1 graph proves that even a rudimentary regression model (with only three independent variables - Land SF, Bldg SF and Bldg Age) is capable of producing a decent market solution. The fit is significantly tighter, especially in the long end of the curve. The R-squared jumps from 0.19 to 0.91, accounting for 90% of the variations in sale prices. But this model has clearly bi-modal issues between 1,000 and 2,200 SF as the regression values are forked. 

FYI – If you see such stacked values, you have to investigate the underlying reason(s). The simple way to identify the issue is to scatter the normalized regression values against the other independent variables as well and look for an explanation.

The above investigation guided me to the solution. As the normalized regression values from the first model were scattered against the Bldg Age variable (above graph), it was evident that many buyers were paying a premium for the younger homes, causing the stack. In fact, a sizeable portion of those buyers were willing to pay over $130/SF for the younger homes, while very few offered such premium for the older ones. More precisely, none paid over $160/SF for the older stock.

(Click on the image to enlarge)

So the Bldg Age variable had to be transformed from continuous to binary (younger homes vs. the rest). The re-run of the regression model with the transformed Bldg Age produced the above (Regression Value-2) graph. Consequently, the value fork has disappeared, translating to a much tighter fit, with improved R-squared, lower intercept and a steeper slope approaching 45 degrees.  

We will discuss the Comp Sales Analysis in a future post (2 of 2).

Good Luck!

Sid Som, MBA, MIM
President, Homequant, Inc.

Wednesday, May 29, 2019

Homequant Offers Sales Ratio Study for SFR Rental Portfolios

Homequant Offers Benchmark Automated Valuation Modeling (AVM)

Tuesday, May 28, 2019

Local Governments should Seriously Consider Outsourcing Non-essential Services

Most people I talk to still define outsourcing as “shipping out” services (hence, American jobs) to highly specialized companies in other countries, especially to the front-runners like China and India. But that’s half the story. The other half of the story is that there are many great American companies that provide very similar services at very competitive rates. Case in point: Why did Amazon decide to set up their HQ2 in Northern Virginia? Very simple: To provide more personalized IT (outsourcing) services to the Federal Agencies and a myriad of major government contractors in the area. Their research must have revealed that these specialized clients would be better served with in-migration of services, rather than from the generic overseas service centers. Needless to say, the great companies like Amazon, Apple and Google spend hefty sums on data R&D in order to stay consistently ahead of the competition.

Likewise, the local governments (counties, cities, towns, etc.) will do themselves a big favor if they start outsourcing some of their non-essential services to such great American companies, without having to worry about the data privacy or compromise of sensitive records, as they tend to have much better systems in place than the local governments can ever envision and implement. It will be win-win, meaning those government services would be more efficient while lessening the financial burden on taxpayers. Let’s save the obvious: Unions, Civil Service, Labor Contracts, Collective Bargaining, etc. Before worrying about such issues, governments and legislative apparatus need to strengthen their will, believing ‘if there is a will, there is a way.’ Granted, it won’t be pretty or perfect to start with, but it will provide a start, the future of which will be brighter by the day.

Now, let’s differentiate between essential and non-essential services. First off, the outsourcing of essential services – law enforcement, public health, public schools, public transportations, public works, correction officers/prison guards, fire fighters, social services, sanitation, the office of management and budget, etc. – is strictly non-negotiable. While both essential and non-essential services are needed, in this day and age when better and faster services are demanded by the public, the need for agency’s direct involvement in providing non-essential services could however be independently studied and decided upon (i.e., the cost-benefit analysis of outsourcing vs. keeping the services in-house). Here are some non-essential services of local governments that would make good outsourcing candidates:

1. Employee Benefits, Payroll and Time Processing – These are some of the most commonly outsourced functions in the private sector. While some small and mid-size local governments have already been outsourcing these functions, the large cities and counties are still far behind. These functions generally return the best bang for the buck when bundled across essential and non-essential services; for instance, there is hardly any difference between the processing of payrolls for law enforcement and that of the assessment office. Managing and processing of human resource components like payrolls, benefits, time, leave, talent, etc. go hand in hand, often inter-connected via the different modules of the same HRIS software, as well as a central customer service system with specialty units. ADP is perhaps the most well-known in this space.

2. Sales Tax Collection and Processing – Many large counties and cities across the country levy additional sales taxes, charging local sales taxes on top of the usual state sales taxes. In addition to the local sales taxes, some of them have local income taxes, commercial rent taxes, sanitation taxes, water district taxes, etc. All of these taxes may be bundled and outsourced to companies specializing in this domain. In many local governments, these taxes are often managed and collected by separate units under different verticals altogether, thus wasting significant taxpayer dollars on redundant or inefficient services that could easily be grouped or combined. In a scenario like that, the outsourcing is the ideal way out, to avoid having to maintain them separately, without any additional return on such parallel and wasteful investments.     

3. Property Data, Assessment and Tax Collection – This is the local juggernaut that needs serious considerations. In fact, if the counties need to just single out one function to begin the “outsourcing” experimentation, this obviously is the one – no two ways about it! As we all know, the local elections are often won or lost on the issue of property assessment alone. Unfortunately, after the winning party takes over, it reinvents the same losing experimentations, expecting different results. Of course, the only long-term solution to this age-old problem is the total abolishment of the existing property tax system and replacing it with a set of middle-class friendly progressive consumption taxes. Meanwhile, the mayors and county executives will hopefully understand the need for real (not make-shift) solutions to this age-old problem and start outsourcing it to quality economic consulting firms. In fact, the leading consulting firms like Accenture, Boston Consulting, Deloitte, EY, KPMG, McKinsey, PwC, etc. should seriously look into this emerging multi-billion dollar outsourcing business. It will be great for taxpayers as well, considering the kind of forward-looking solutions these firms will finally bring in. Taxpayer advocacy groups must also fight to have the full assessment umbrella outsourced, helping taxpayers get out of this unfair cycle they have been trapped in for a long, long time.

4. Property Tax Appeals Review and Processing – In an effort to provide fair and independent review and processing of property tax appeals, both residential and commercial, almost all major jurisdictions have established separate bodies (departments, agencies, statutory commissions, etc.), and some are larger (in headcount) than the vast majority of mid-size assessment offices. Since the day-to-day functioning of these bodies does not depend on the assessment office, they could easily be outsourced to economic consulting firms as well, eventually saving taxpayers a ton. Additionally, their AI-based expert system will do a much better job in introducing true fairness and equity in the appeals system. Their solution could then be ploughed back into the tax roll, forcing the assessment staff to improve the overall quality of future rolls. As long as the property assessment system is alive and ticking, the rapid introduction of AI-based solutions is the only meaningful way forward. And, that is possible with the direct outsourcing of the assessment review functions to the major consulting firms.

5. Information Technology (IT) and Help-Desk Services – This is the most common service in the private sector that gets outsourced to the specialized global players like Accenture, IBM, Capgemini, TCS, Infosys, etc. Local governments should also consider outsourcing these services to well-known companies, not only for efficiency, cost improvement and scalability but also for minimizing redundancy and duplications. In any case, whenever they need enterprise-level applications and solutions, they depend on outside vendors. Unfortunately, the applications they develop in-house are generally low quality and ad hoc. For example, in this age of modern technology, they still take pride in developing applications in MS-Access that their own IT does not support. This is a terrible use of taxpayer dollars. Even when the outside vendors are used, the RFPs are circulated within a very limited pool of vendors, that are rarely known for the world-class quality and service taxpayers would expect. Even within the local government, agencies are generally run mutually exclusively, generating significant amount of duplication of services. Outsourcing is the only way to address these inefficiencies and minimize the resulting wastefulness.

6. Public Parking Maintenance and Traffic Ticket Processing – Private operators like Laz are already managing numerous public garages and surface lots for government agencies. Similarly, there are many private companies that help governments process parking and traffic tickets. Considering the fact that these companies not only use cutting edge technologies, but they also continually upgrade them to remain competitive. Some of them also provide general (parking) building and lot maintenance services, and arrange for renovation and reconstruction services. Some companies even work with the Wall Street investment firms to help issue bonds and/or securitize the revenue streams.  Therefore, the outsourcing of parking and traffic ticket processing services makes the system, on the whole, a lot more efficient, generating significant amount of savings for the government agencies over a period of time.

7. Public Housing Maintenance and Rental Processing – In almost all major cities in this country there are local government (owned and) operated affordable public housing. For instance, the NYC Housing Authority provides housing for over 400,000 low and moderate income residents and employs over 13,000 employees. A number of their basic services like rent and application processing, building maintenance, safety and security, etc. could be outsourced. Obviously, it makes no economic sense to use the regular law enforcement personnel to provide the basic safety and security services for those facilities, which unfortunately is quite common; in fact, outsourcing the security service to established private security firms would be just fine. Some of these government agencies even provide free vocational and financial education, job training, transportation, child/day care and a host of other subsidized services in partnership with other social service agencies and non-profit organizations, so those services could easily be outsourced as well. Of course, the same case can also be made for the maintenance of all office buildings owned and operated by local governments. 

8. Public Parks and Recreation Facilities – Many parks and recreation facilities are within the jurisdiction of the local governments. They can either be leased to the private institutions or run as joint ventures with revenue-sharing agreements. Under the private auspices, these facilities will not only be better managed and run, but they will also free up the local governments of the on-going fixed overheads. Selling naming rights to those facilities, especially of the round-the-year recreational components like indoor swimming pools, skating rinks, bowling alleys, golf courses, marinas, etc., could also be viable revenue options. Land lease for future restaurants, food courts, 3D movie theatres, concert halls, science parks, miniature golf, Go Karts, etc. within popular parks are other revenue options.   

9. Management of Shelters for Women and Children – Almost all major local governments operate shelters for women and children. Instead of having to rent from slum landlords and unsafe hotels and motels, government agencies should seriously consider working with quality private operators where the operators own and operate dedicated facilities – in line with the private adult homes – with better living conditions, safety, job training, day care, emotional therapy, transportation services, etc. It’s totally immoral to house these unfortunate women and children in poor and unsafe facilities. Of course, the emphasis must always be on job training and education so these facilities continue to serve only as transitional facilities. It’s equally immoral to operate juvenile detention centers. Instead of building and operating such detention centers, governments must hire more social workers, school counselors and adolescent/family therapists, thereby creating long-term solutions to the growing juvenile issues.

As we all know, labor unions are very powerful so they will fight tooth and nail to protect the status quo. By the same token, the new generation of local politicians must campaign and run on platforms that protect taxpayers from the mounting tax burdens. They need to approach and market the outsourcing issue on humane grounds, walking down on the curve where taxpayers are currently being the hardest-hit. Obviously, one of the most critical areas is the out-of-control property taxes that heavily favor the rich at the expense of the poor and middle-class, of whom the minorities and seniors suffer the most, often to the extent that they are ousted from their roots. Therefore, the umbrella of property assessment and taxes should be the mother of all outsourcing for local governments. 

The next on the queue should be the establishment of a central processing agency across the entire local government which will process the vast majority of services indicated above, thus removing the need for agency-wise duplication of expensive infrastructure, personnel and mutually exclusive processing. The advantage of having a central processing agency is that people could be cross-trained on variety of related processing, gradually ironing out the seasonal impact (seasonality) from the different services. Again, unions are not going to be silent spectators but the concept of central processing (in-house) might be an easier sell than the outright outsourcing of other services to external institutions. The time is now to emancipate the maxed out taxpayers.

Thank You.

Sid Som MBA, MIM
President, Homequant, Inc.

Also Read:
Income Disparity is at an All-time High. What should we do about it? (Part 1 of 2)

Income Disparity is at an All-time High. What should we do about it? (Part 2 of 2) 

Coming Soon...Sid's New Book: 
Life, Logic and the Power of Nine (Branding)

Homequant Offers Automated Valuation Modeling (AVM) for SFR Rental Portfolios

Homequant Offers AVM and CAMA Modeling Service