The Problem with Software Estimated Return

Photo by Lagos Techie on Unsplash

I am occasionally asked why the return estimates generated by the investor tool are not more accurate. In this article, I will explain the problem with all software-generated comps.

The Challenge

Computer software is limited to objective data, square feet, baths, bedrooms, etc. Zillow, Redfin, Trulia, and our Investor Tool all share the same problem. In our process, the number one job of the investor tool is not accurately estimating return. The primary job is selecting the tiny set of properties from thousands that conform to our property profile. Secondarily, a first pass at estimating return. See the diagram below.

The reason all software-selected comps provide inaccurate return estimates is that it requires comparable sales and rentals. The key word in the prior sentence is comparable. Unfortunately, selecting properties that are comparable to the subject property. Below are two examples of the problem software faces when selecting comps.

In the above aerial view, the subject property is adjacent to a freeway. There is lots of traffic noise and the house would rent for far less than if it was only 500 feet further away. In general, the software has no ability to observe search nuisances and make corrections for them.

In this case, the subject property is very close to a different community with a much higher dollar per square foot. As the software searches for comps within a specific radius of the subject property, it may select comps that are not comparable, which skews the return estimate.

How We Incrementally Improve Return Accuracy

As properties progress through our multi-step validation process, additional information becomes available at each step. Based on the additional information, we refine the Property Report information. See the diagram below.

Return is reevaluated six times during our validation process. And, if we have an estimated renovation cost, we include this in the return calculation. Then, after the property is under contract and we have the property inspector and the property manager evaluations plus quotes for all work, we recalculate return. If the return is not satisfactory, we cancel the purchase and find another property.

In Conclusion

It is impossible to generate accurate returns using only objective data, which all software has to work with. Only a team of experts reevaluating return at all steps in the validation process can provide the level of accuracy needed to make a final go / no-go decision on buying property.