Automated valuation models have largely been hidden backroom functions but have recently become more widely talked about for two reasons.The first was the introduction of home information packs by the Government. Under the original proposals, a home condition report was a compulsory part of every Hip but did not include a valuation. Lenders said they would still require a standard valuation to be carried out, which would impose an additional cost on the buying process. AVMs were put forward as a possible solution as they overcame the need for the lender to undertake a physical valuation of the property but the Government had a change of heart and home condition reports are no longer a mandatory part of Hips. The second reason for AVMs to become more widely known has been the launch of instant online offers. Intense competition means that an increasing number of lenders are likely to launch instant online offers and the use of AVMs has been fundamental to their development. Although lenders have been able to access instant credit reference and electoral roll data online, they still have to instruct a valuer to undertake a physical valuation of a property. This process can take several days and any offer has therefore been conditional. What are AVMs and how do they work? AVMs do not require a physical valuation to be conducted. House price data from the Land Registry and other sources is combined with information about the property type and condition to calculate a valuation for a specific property. To understand how this statistical alchemy works, consider an example. In a row of four identical houses, if three out of four have been sold recently for 250,000, it stands to reason that the fourth is probably also worth 250,000. But a row of houses is rarely identical, either in type or condition, and it is also rare for similar houses to have been sold at a similar time. That is where the clever computing comes into play. The variables are taken into consideration and a valuation – including a confidence factor for the valuation – is produced. One of the leading providers of this type of technology is Hometrack, which claims that its Realtime valuation system is used by over 70 per cent of lenders and its Realtime pre-valuation system is used by over 90 per cent of second-charge and sub-prime lenders. The system has a database of more than 22 million units of property data and Realtime produces more than 10 per cent of the UK’s residential valuations each year. Perhaps the final endorsement which AVMs have needed has come from the rating agencies, Standard & Poor’s, Fitch and Moody’s. These agencies rate lenders’ securitisation deals and AVMs provide an excellent way for lenders to value a portfolio of mortgages. Actually, it is not the role of rating agencies to endorse AVMs – they simply give a view on the risks associated with their use – but most agencies have issued guidelines on the treatment of AVM-valued assets. Rating agencies do perceive a greater risk when using AVMs and will apply what is know as a “haircut” – a reduction in the valuations. The severity of the haircut s determined by the confidence level that the AVM provider attributes to each valuation. Lenders will also limit the percentage of AVMs used as part of a specific pool of securitised mortgages. In a first pool, for example, the level of AVM use may be 5 per cent, in the second 10 per cent and so forth. This is to enable the investors who buy the bonds to become used to the increased use of AVMs. AVMs have reached a point where they are an essential tool for most lenders. There is a danger that AVMs are seen as the perfect solution to every situation, which is not the case. Research undertaken by the Council of Mortgage Lenders confirmed that at the end of 2005, only 25 per cent of lenders were using AVMs for some of their property valuations, primarily remortgaging and further advances. The research asked lenders to anticipate how the use of AVMs will change over the next five years and the result was that lenders believe AVMs will account for only 38 per cent of all valuations by 2012. This means that 62 per cent will continue to be carried out using physical inspections. Why the relatively low take-up of AVMs? Lenders do not like using AVMs when loan-to-value ratios are high or for high-value properties. This is for exactly the same reason why rating agencies apply haircuts – AVMs are not infallible and there is scope for inaccuracy. Some properties are also difficult to value using AVMs, such as newly built houses, flats, properties of non-standard construction and unusual properties. Properties which are likely to be in poor condition, such as repossessed properties, will also require a physical inspection. Lenders prefer using AVMs for remortgages and further advances rather than house purchase. AVMs will not threaten the livelihood of valuers for some time to come. Most mortgages will still require a physical valuation for the foreseeable future. Which brings us back to instant online offers. These are a significant step forward but intermediaries cannot bank on being able to get an instant offer every time. Instant offers are not necessary in most cases and a delay of a few days for a valuation to be carried out will not be detrimental to the client.