Helpful InformationStrategy November 10, 2021

The Zillow Algorithm vs. The Human Algorithm

 

The recent news of Zillow’s plan to shut down their iBuyer program due to a $328 million loss in the third quarter has heads spinning in the real estate world and on Wall Street.  Sadly, Zillow plans to eliminate 25% of its workforce because of its decision to move away from the practice of purchasing and re-selling homes due to their mismanagement of property price evaluations.  “Fundamentally, we have been unable to predict the future pricing of homes to a level of accuracy that makes this a safe business to be in,” Zillow CEO Rich Barton.

This is a bold statement from a CEO who built their company on a computer algorithm that spits out a home value called, the Zestimate.  A Zestimate is an AVM (Automated Valuation Model).  The product of an automated valuation technology comes from analysis of public record data and computer decision logic combined to provide a calculated estimate of a probable selling price of a residential property.  An AVM generally uses a combination of two types of evaluation, a hedonic model and a repeat sales index.  The results of each are weighted, analyzed, and then reported as a final estimate of value based on a requested date.

Zillow’s iBuyer program sought to find eager home sellers who wanted a quick, no-nonsense sale.  They would present a cash offer based on their algorithm and close on a mutually agreed-upon date.  After closing, Zillow would turn these properties around with some improvements and bring them back to the market.  This is often labeled a “flip”.  The problem was Zillow overpaid for the majority of their purchases which proved that their computer-generated evaluation (AVM) lacks market accuracy.

On average, they re-sold these homes for $80,800 less than what they purchased them for.  Thorough market research that includes touring the subject and neighboring properties, seeking info from other brokers about the terms of recent sales and overall experience helps to determine accurate market conditions in comparison to the swirl of data used to establish the Zestimate.  Computers can’t do this type of in-depth research, nor do they have the instinct to predict shifts in the market, but humans (real estate brokers) can!

Often times when we are talking with potential sellers, their Zestimate (or other AVMs) come up in the overall conversation. We understand why, too. This is information that is relatively easy to access and gives the seller a starting point on the value of their home. Where an AVM can become dangerous is when a consumer thinks it’s the be-all, end-all. Even worse, when a consumer makes a major financial decision solely based on this information. According to Zillow, 39% of all Zestimates in the Seattle metro area are not within 5% of the actual value. In fact, they publish an accuracy report that you can access here.

In October, the median home price in the Seattle Metro area was $850,000. With 39% of all Zestimates not within 5% of the actual value, that is a beginning margin of error of $42,500! Further, they claim that 82% of their Zestimates are within 10% of the actual value, which is a marked difference – up to $85,000. Where AVMs are incomplete is that the basis of their formula is tax records, which in my experience are often inaccurate. Also, and most importantly, an AVM does not take into consideration the condition of the home, the neighborhood, and other environmental impacts such as school district, road noise, and unsightly neighboring homes, to name a few.

So why does the Zestimate exist? Zillow is a publicly-traded company (ZG) and their website is the vehicle to create profit. The Zestimate drives consumers to the website who are often dipping their toes in the pool to see what their home might be worth or searching available homes for sale. When a consumer is searching on Zillow’s website they are surrounded by real estate broker and mortgage broker ads on every page. These real estate brokers and mortgage brokers are paying for that advertising space, which is how Zillow makes its money and why there is a Zestimate. The Zestimate is not a public service, it is a widget to bring eyes to their advertising space which in turn, sells more ads to brokers looking for leads.

The moral of the story is this: use Zillow as one of the many tools in your real estate evaluation and search toolbox. Zillow provides a great starting point and contains a ton of information to whet your palate when embarking on a real estate endeavor. However, we live in a time of information overload and we are overstimulated at best. Nothing beats the evaluation and discernment of a knowledgeable and experienced real estate broker to help you determine accuracy, which will lead to the empowerment of clarity.  At Windermere, we like to call this, The Human Algorithm.

If you are curious about the value of your home in today’s market, please contact me. We can provide an annual real estate review of all of your real estate holdings, and can review a complete comparative market analysis if you would find that helpful. It is our goal to help keep our clients informed and empower strong decisions.