How investors can use After Repair Value (ARV)
If you are looking to get into real estate investing and house flipping, you’ll want to know about after repair value. ARV is an invaluable tool for investors that can help them determine the best properties to go after and the price tag they’re willing to pay.
Here's what you need to know about real estate investing and after repair value.
What is After Repair Value in real estate investing?
ARV is a term used to describe the projected value of a distressed property after repairs or renovations.
Investors and wholesalers often use the metric to decide whether a property is a worthwhile investment. Additionally, it can help them determine the sales price range they're willing to engage in.
How does ARV help investors?
There are three main ways ARV can help investors.
- Calculate a sales price ceiling
- Create a budget for repairs and renovations
- Identify an estimated profit margin
How to calculate after repair value (ARV)
There are three main steps to calculating ARV:
- Run a comparative market analysis.
- Estimate the cost of repairs.
- Use the 70 percent rule.
1. Comparative market analysis (CMA)
To start, investors will need to do a comparative market analysis (CMA) to evaluate similar properties in the area. These comparable properties, often called comps, can be found through venues such as the Multiple Listing Service (MLS) or Pointer Data's property listing platform.
Many investors try to find three to six comparable properties that sold roughly 90 days prior — too far out, and your figures won't be as accurate. From here, you'll compile data to get an idea of what your property could go for.
The CMA will consider what the comparable properties sold for and factor in things like the neighborhood, square footage, the number of rooms, property condition, lot size, and age of the home.
If a property has a feature that is either superior or inferior to the comps, you will make adjustments to the property values.
2. Estimate cost of repairs
The second step will be to determine how much you will be spending on repairs and renovations.
One way to estimate the cost of repairs is to contact multiple contractors and ask for itemized quotes. Doing so will give you an idea of what you'll be spending and ensure you're getting the best deal.
3. Use the 70 percent rule.
The 70 percent rule in real estate refers to the rule investors use to determine how much they should pay for a fixer-upper. In other words, investors should stay away from properties whose price exceeds 70% of the future value after the costs of renovations.
The 30% margin makes room for the return on investment but also provides space for error. If you underestimate the cost of repairs or overestimate the ARV, your margin for profit can be seriously affected. Best to give yourself room for mistakes.
See below for an example of ARV and the 70 percent rule in action.
The 70 percent rule and ARV in real estate
After you have run a comparative market analysis and estimated the cost of repairs, it's time to plug those numbers into the following formula. This formula will help you determine the maximum purchase price for a potential investment property based on the 70 percent rule.
Maximum Purchase Price = (ARV x 70%) – Repair Cost
Now, let's put this into practical use.
Let's say that after your CMA, you've determined the average going price for comparable homes in your target area is $200,000 — this is your ARV. You've also established that repairs will cost around $30,000. With these numbers, you can calculate what the max sale price of the property should be.
($200,000 ARV x 70% = $140,000) – $30,000 repair cost = $110,000 maximum purchase price
Based on this example, the maximum sales price for the property as-is would be $110,000.
Calculating profit margin
The great thing about the ARV is that it can be used for both short-term and long-term investment strategies. If you focus solely on flipping to sell, you need to consider how much you'll make in pure profit down the road.
We know we've invested roughly $140,000 into the property between the sales price and the renovations.
$110,000 max purchase price + $30,000 repair costs = $140,000 total amount invested in property
Now, we want to know how much we can expect to profit after selling the flip. Using this example, we can predict that the projected profit will run around $60,000.
Here is how the numbers break down.
$140,000 total invested – $200,000 after repair value = $60,000 potential profit before closing costs
Things to consider with ARV
ARV can be a valuable tool for investors and significantly impact their portfolio's overall success. Before diving into your first after repair value calculation, consider the following:
- At first, you may find ARV calculations to be tedious and all-consuming. But just like anything else in investing, the more you use it, the better you'll be at it. Put the required effort into learning to calculate accurate ARVs now so you can set your investment business up for success in the long term.
- Choosing the wrong comps can negatively affect the accuracy of your ARV and lead to you paying higher than you should for an as-is property.
- The more realistic you are with renovation estimates, the more accurate your max value calculation will be. Over time you will want to build relationships with contractors and handymen to have a trustworthy team on deck. Getting started, you'll want to get to know different vendors and ask for quotes.
- Market conditions for labor, supplies, and materials can fluctuate over short periods of time. Be prepared to make adjustments to your ARV estimates and consider both overall economic trends as well as localized movements in your market.