ARV is an important term to understand for real estate investors who are buying a home that needs significant repairs. In this article, we’ll explain how ARV in real estate works, and how investors can use ARV to help avoid overpaying for a property that needs renovating.
- ARV (after repair value) estimates the potential value of a property after all repairs have been made.
- After repair value is used by wholesalers, fix-and-flip investors, and property owners to determine the potential profit on renovations and updating.
- Conducting a comparative market analysis and accurately estimating the cost of repairs are two key parts of accurately determining ARV.
- Many investors use the 70% Rule with ARV to determine the maximum purchase price of a home that needs to be renovated.
What is After Repair Value in Real Estate?
After repair value (ARV) is the projected value of a property after it has been repaired, renovated, or updated.
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.
If the planned renovation doesn’t generate a good return on investment (ROI) with a higher rent price or forced appreciation, the upgrading may not be worth doing.
How to Determine ARV for Real Estate
There are two steps to calculate after repair value in real estate:
1. Run & Analyze Comparables
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.
When selecting comparable properties to determine ARV, investors look for:
- Property that has been sold in the last 30 to 60 days.
- Property in the same neighborhood or subdivision.
- Property with similar characteristics to the one being renovated such as square footage, number of bedrooms and bathrooms, lot size, age, and condition.
Because no two homes are exactly the same, adjustments are made to the comparable property values.
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.
By adjusting comparable values, an investor is able to determine the after repair value of the home being renovated to similar properties that have recently sold.
2. Determine Renovation Costs
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.
There are three steps investors can take to help ensure renovation costs are estimated as accurately as possible:
- Obtain detailed estimates from at least three contractors, making sure that the quotes are itemized. Sometimes a contractor will underestimate the labor cost involved in a project, then try to renegotiate once the bid has been accepted and the work is underway. Having three estimates to compare allows an investor to identify if one contractor’s price may be out of line.
- Use construction materials and finishings that will attract the target buyer or renter once the property is renovated. For example, tenants with pets may only want carpeting in the bedrooms and tile or hardwood in the rest of the house. Knowing the profile of a potential buyer or renter helps to create a more realistic renovation budget.
- Factor in the holding and carrying cost of the property during the time it is being renovated. If a rental property is undergoing a significant amount of renovation between tenant turns, the property will be vacant with no rental income generated. However, operating expenses, property taxes, and the mortgage will still need to be paid.
The 70% Rule and ARV in Real Estate
Once the after repair value and cost of repairs have been accurately determined, investors use the 70% Rule to determine the maximum purchase price to pay for a property.
- Maximum Purchase Price = (ARV x 70%) – Repair Cost
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.
To illustrate, we’ll use a single-family home in Kansas City, Missouri.
According to Zillow, the value of a typical home in the middle tier price range in Kansas City is $198,267. Now, let’s assume an investor locates a fixer-upper that requires $30,000 in repairs.
The investor can now use the 70% Rule to determine the maximum purchase price of the fixer-upper home:
- Maximum Purchase Price = (ARV x 70%) – Repair Cost
- ($198,267 ARV x 70% = $138,787) – $30,000 repair cost = $108,787 maximum purchase price
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:
- $108,787 purchase price + $30,000 repair costs = $138,787 total amount invested in property
- $138,787 – $198,267 after repair value = $59,480 potential profit before closing costs
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.
By not deviating from the 70% Rule, a real estate investor can help to minimize the risk of losing money when renovating and selling a fixer-upper.
6 Tips for Using ARV in Real Estate
For many real estate investors, establishing the after repair value is relatively easy. The trick is accurately estimating the cost of repairs and buying the right property at the right price.
There are several tips for using ARV that investors keep in mind:
- Property after repair value must reflect current real estate market conditions after the repairs are done. The quicker repairs are made and the renovated property is listed for sale, the lower the risk that the market will change.
- Investors should use their own cost and ARV estimates when analyzing potential deals. SEllers or real estate investors may underestimate the cost of needed repairs or overestimate the resale value when presenting an opportunity to another investor.
- Due diligence should be completed before closing on a fixer-upper. For example, an investor may budget for replacing the carpeting but not realize that there is black mold growth along the baseboards until the carpet is pulled. The cost of professional mold remediation can run between $500 and $6,000 or more if the mold is severe, significantly reducing any potential profits from the fixer upper.
- Potential return depends on accurately estimating repairs and convincing a property owner to sell at less than the fair market value. If an investor is good at calculating repair costs but lacks sales skills, it may be a good idea to partner with another investor who is a shrewd negotiator.
- Homes that need renovating can sometimes be difficult to find. One good place to look for potential deals is the Roofstock Marketplace. By selecting “cash only” in the search criteria, investors may be able to locate homes that are priced below market for a potential double-digit gross yield once repairs are made.
- Appraisers may not agree with an investor’s estimated after repair value. If the property doesn’t appraise for at least the purchase price, the investor may need to reduce the asking price so that the buyer can obtain financing. Many investors who are new to buying property to renovate usually look for property with easy updates such as replacing flooring and kitchen cabinetry, and save major renovations for when they have more practice with ARV.
Final Thoughts on ARV
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.