Pros and Cons of Using Online Home Valuation Tools

There's an adage in the real estate industry that suggests all homeowners are prospective investors. The basis for adage is the idea that a primary residence, while serving as a place to live, is also a significant financial asset that can appreciate in value over time. For every homeowner who is not interested in selling, 10 others think about the potential profits their properties could generate, thus explaining the popularity of online home valuation tools.

To a certain extent, owning a home and being able to make money from it are parts of the American Dream. Historically, real estate has appreciated in value over the long term. Market fluctuations are inevitable; the same can be said about boom and bust cycles, but the appreciation of real property values is inherent. This presents a potential to strengthen the financial position of homeowners, and it is a strong pillar of the real estate industry.

For many Americans, checking how much their homes are worth is a financial pastime. Home valuation is a topic covered by news media outlets; if you search online for headlines about property values, you will find dozens published daily across various regional markets. Median property values are barometers for the nationwide housing economy; they are of interest to prospective buyers, sellers, Realtors, mortgage lenders, economists, financial planners, investors, journalists, and even individuals who are curious about the real estate market.

For real estate analytics giants such as Zillow, a tech startup that generates almost $2 billion in annual revenue, providing online tools for property valuation is a crucial aspect of their business model. When Zillow launched in 2006, two years before the housing market crashed, the Zestimate was the company's primary product. The first version was a visualization of market values represented by pins on a map; later, Zillow executives realized that visitors preferred to see single price points, so the Zestimate was changed into the version that most people are familiar with today.

Getting a Zestimate today is as simple as visiting Zillow's website and navigating to the home value estimator tool, entering the street address of the subject property, and getting a dollar amount in seconds. Zestimates are free and accessible from web browsers or the Zillow mobile apps, thus underscoring their main advantage.

The original version of the Zestimate that displays a neighborhood map with values for multiple homes is still available under the "Buy" section of the website, which borrows some elements from the user interfaces of Multiple Listing Service (MLS) platforms. Popular online tools that compete with Zillow include Redfin and Xome; plus, major mortgage lenders from Bank of America to Chase also offer home valuation estimates to prospective mortgage borrowers.

We mention Redfin and Zillow because both companies provide commercial access to their application programming interfaces (APIs), so you may see their valuation estimates on other websites. Mortgage lenders, real estate firms, and financial news publications are among the main API clients of these companies, and they have almost cornered the market in this regard. This is a disadvantage to property owners who think they are getting a proprietary valuation, when in reality they are getting estimates from Redfin or Zillow.

It is imperative for users of online home valuation tools to understand what the estimates truly represent and how accurate they are. What you get from Zestimates and Redfin estimates are real-time market values. The real-time factor is vital for most housing market participants from investors to sellers and from buyers to Realtors; however, they don't always represent true property values, particularly in seller's markets where housing supply shortages result in speculation.

Many industry analysts and market researchers have noticed that the Zestimate is often overly positive, particularly when users search for values in hot property markets. Zillow has faced lawsuits and criticism over the accuracy of its Zestimates, with some plaintiffs arguing that they can be misleading and contribute to market distortions. There's an industry term for this observation; it is called the "Zillow Bubble," and it calls out the Zestimate feedback loop, wherein high estimates lead to higher prices, thus leading to even higher estimates. Some critics point out Zillow's financial motivation to entice sellers to list their properties, upload images, and provide real estate data that is highly valuable for the company, thus explaining the overly positive Zestimates.

Free online property valuations like the Zestimate are essentially consumer-grade versions of automated valuation models (AVMs), which have been used by Realtors since the 1980s. Both methods utilize statistical modeling and algorithms to generate property valuations based on available data. The data typically includes public records and tax assessments, but the real-time factor emphasizes recent sales data of comparable properties in the area. Both methods are predictive to a great extent because no one knows what will ultimately happen at the closing table, but the AVMs used by real estate professionals and financial institutions use more comprehensive and higher-quality data sources.

Professional AVMs pull data from proprietary databases and more granular market information. They may also incorporate more sophisticated statistical techniques and algorithms, thus allowing for more precise adjustments based on known property features and local market conditions. Zestimates and similar free valuation tools are better at providing a picture of how the market is moving than delivering accurate values.

The ultimate validity of the data generated by free online valuation tools is what prospective sellers should fully understand. Unless the loan-to-value (LTV) ratio is 50% or less, mortgage lenders will not approve, process, or close application with a Zestimate, but they may do so with a professional AVM, especially when the deal involves a streamlined refinance transaction of an existing borrower or a home equity line of credit that leaves the LTV ratio below 80%.

The bottom line of AVMs versus Zestimates and other tools is that the former are more accepted, accurate, and recognized in the real estate and mortgage industries. Online valuation tools are good barometers of regional and local housing markets, and they are great for quick reference, but they should not drive real estate transactions. If a home purchase or refinance transaction does not require a full Uniform Residential Appraisal Report on a Fannie Mae 1004 form, it should include at least an AVM report, but never a Zestimate.