Estimated Repair Value
Sandra Grady
Investors create a comparative market analysis (CMA) to learn what properties similar to the one to be rehabbed have recently sold for, based on metrics such as square footage, number of bedrooms and bathrooms, lot size, age, and condition.
ARV is normally used by investors who fix-and-flip or wholesale real estate. Higher-risk investment strategies like these require the property to be purchased at a low enough price so that a profit can be generated after all repairs have been made.
Real estate investors using the value-add strategy also use after repair value to determine how much value a planned upgrade or renovation will add to the property, and whether or not the potential gain in value is greater than the money spent on updating.
Comparable properties (or comps) are homes that are most similar to the property being renovated that have recently sold. Comps are easiest to run with access to the Multiple Listing Service (MLS). Many real estate agents are willing to compile a comparable report at no charge in hope of generating some future business, such as leasing or selling the property being renovated.
If a comp has a superior feature such as more square footage, a value deduction is made to the comp. On the other hand, if a comp has an inferior feature, such as a roof in need of repair, value is added to the comp.
Accurately calculating costs and expenses to repair, renovate, or update a property is the second step to calculate ARV for real estate. Knowing how much money needs to be spent to improve the property directly impacts the maximum purchase price of the property being acquired for renovation.
Investors need to purchase a fixer-upper property below market value in order to make a profit. According to the 70% Rule, the price paid for a property being renovated should never exceed 70% of the future value of the property after repair costs have been factored in.
Based on this example, if the investor were to sell the property after completing the repairs, the investor would earn a potential profit of $59,480 based on the estimated repair costs and after repair value of the home:
Having nearly $60K in potential profit also provides the investor plenty of margin for error. For example, the cost of materials used in the renovation could increase due to a supply shortage, or the real estate market could begin a downward cycle.
After repair value (ARV) is an important calculation used by real estate investors who wholesale, fix-and-flip, or purchase value add real estate. ARV can help an investor decide whether a deal is too good to pass up, or one that may end up losing money.
Many investors use the 70% Rule with ARV to determine the maximum purchase price to pay for a property that needs to be renovated. While investors use other metrics in addition to after repair value, ARV is a key consideration when buying property that needs significant repairs.
ARV is the estimated value of a property after completed renovations, not in its current condition. House flippers commonly use ARV as a way to gauge the worth of a fixer-upper property, including how much it can be bought, and then resold for after repairs. The repairs or renovations can be anything from installing new kitchen appliances to replacing the roof.
One of the most important things you can do to calculate ARV more accurately is to have your home appraised. Knowing the current value of your home helps give a better idea of what your property is worth before the value of renovations is added.
Once the appraiser has checked out every aspect of the home, they can give you an estimate of the current value. Knowing the current value of your home can give you a more concrete starting point when calculating your ARV, which will make the value you come up with more accurate.
Though an appraiser mainly looks at your home to determine the market value, they can also point out repairs that need to be made and potentially even what those repairs will cost. Finding anything that might need fixing in addition to your planned repairs will prevent you from encountering unexpected costs after already calculating and using the ARV.
ARV only accounts for the value and potential value of a property during the time window in which it is estimated. Even after looking at comparable properties and checking for repairs that may need to be made, things can come up and change the value.
With the limitations and downsides of ARV in mind, it may seem risky to estimate the value at all. In the house flipping business, however, ARV is still a handy rule of thumb, despite the potential for loss that comes with it.
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Annual rental value is sometimes incorrectly confused with after repair value, though the two are completely different metrics. Annual rental value refers to the yearly cost for an occupied space. This does not necessarily equate to the annual rent of a property but instead takes comparable properties and occupancy costs into account. Annual rent value is typically used when calculating the business costs associated with occupying a given space. To keep the two terms separate, investors need to understand the difference between the two metrics. Each calculation can be helpful for your career as a real estate investor, so make sure you have a good understanding.
The option to hire an agent or appraiser to help in a deal analysis is always there; however, they cannot decide whether or not a property is worth pursuing. Many investors have an agent or appraiser within their real estate team or at least network. They can lend an invaluable skillset to the investing process, but investors may find they are better equipped to run certain numbers themselves when evaluating properties.
The reason for this is twofold: money and time. First, an agent or appraiser will more than likely charge a fee for their time, a cost investors may want to avoid if they are evaluating multiple properties to find the right one. Next, involving a real estate professional in your deal analysis can slow down the process. This can prevent investors from quickly evaluating deals for their portfolios. The knowledge of real estate professionals (such as agents and appraisers) can be invaluable to a real estate transaction. However, investors may find more success in creating a deal analyzer of their own.
To obtain detailed information on comparable properties, investors will want access to MLS, or Multiple Listing Service. This will provide the most details on a property that is up for sale or recently sold. Investors should also consider recently sold comps for bank-owned properties (REOs) and short-sales, depending on the amount of comparables found on MLS. Investors should pay special considerations to the following:
Investors should also consider current market conditions and trends, as well as seasonal price changes. This will enable investors to gain insight on both the resale value of a property as well as the optimal time of year to buy or sell.
Although ARV is not an absolute science, it can still be extremely useful when flipping houses. ARV offers a great place for investors to start their estimations for how much they should be for a home, as well as how much it will cost to repair in order to be sold for a profit. This calculation also allows the investor to secure funding for the repairs on the home, as well as potentially get the home at a discounted price. Using your ARV calculation in another formula, called the 70% rule, will allow you to determine the price you should purchase a home for when trying to flip it for a profit.
The 70% rule in real estate is a way to determine the correct purchase price for a rehab property. It is a real estate formula that compares the cost and profit margin of purchasing a distressed real estate property. This number will essentially tell an investor how much you can pay for a property by accounting for the ARV and estimated repair costs. To calculate the ARV, investors can follow this formula:
These variables suggest the ARV of the property will be $250,000. Therefore, the maximum purchase price of the property should be $145,000. Investors can use this information before making an offer to ensure they are getting the most out of a deal. While the 70 percent rule is not necessary, it is a great way for investors to protect their bottom line and maximize overall profits.
The 70% rule has been widely adopted in the real estate industry as a guideline for quickly reviewing rehab properties. However, there are some outliers to be aware of when using this formula. If a property has a low ARV, the 70% rule may need to be adjusted to ensure investors maximize their potential profits. For example, if the ARV of a property only guarantees a few thousand dollars in profits, investors should consider a lower purchase price to increase the profit margins. To adjust the formula for low-ARV properties, try decreasing the 70 percent.
Properties with a relatively high ARV may also require some adjustments when looking at the 70% rule. When it comes to high-value properties, investors may not be able to make offers that align with the formula. For example, if a property has a market value of $600,000, repairs will cost $75,000, and the ARV is $800,000. The 70% rule suggests that investors should offer around $485,000 for the property. Most owners of high-value properties will not accept that much under the asking price, even if the property is in poor condition. Therefore, investors may want to increase the 70% to boost their chances of securing the property.
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