Whether you are planning to purchase a new house for your family or invest in real estate, calculating and knowing the ARV (after-repair value) is a lifesaver. ARV is a very important metric for investors and buyers as it helps them estimate a property's price after renovations.
To determine the After-Repair Value (ARV), a comprehensive analysis of local market dynamics and the expenses associated with necessary repairs must be incorporated to determine the After-Repair Value (ARV). Nevertheless, predicting accurate figures for repair costs can be challenging. Thus, the ARV estimate might be subject to fluctuations due to external market factors. Consequently, the final estimate may not always align with complete accuracy. Here's all you need to know about ARV (after-repair value).
Get A Free Mortgage QuoteWhat Is ARV (After Repair Value)?
After-repair value (ARV) is the estimated value of a property after the renovations have been completed. While the letter "R" represents the "repairs," it includes all kinds of renovations that will be made to the property.
Serving as a valuable tool, ARV helps property buyers and investors in gauging potential risks while purchasing a new property that's in dire need of renovations or improvements. For real estate investors and house flippers, the ARV plays a pivotal role in project viability. The final ARV figure can significantly impact the project's profitability. Therefore, adhering to certain rules, often employed by real estate investors and flippers, becomes essential to safeguard their financial interests and bottom line.
Why Should I Use ARV?
Determining ARV can yield valuable advantages for both property sellers and buyers. Some key benefits of using ARV are given below:
- Finalizing a Sale Price: Knowing the ARV enables sellers in setting the right sale price for their property.
- Cost-Benefit Analysis: Using the ARV process can help investors assess the potential returns and repair costs, helping them decide whether the investment aligns with their risk tolerance and financial goals.
- Calculating Future Profit: Estimating the repair costs and the increase in property value can help investors establish an accurate budget for the construction, mitigating the risk of overspending. Budgetary control is essential to gauge the profitability of the property after the necessary repairs and improvements are carried out.
- Excellent Negotiation: ARV acts as a valuable negotiation tool, benefiting both parties. Sellers can substantiate their asking price based on the property's estimated post-repair value, while buyers can negotiate with a clearer understanding of the property's worth.
How Can I Calculate the After-Repair Value (ARV) in the Real Estate Industry?
Let's start by shedding light on the formula to calculate ARV (after-repair value):
The Current Value of a Property + Estimated Value of Repairs and Renovations = ARV
Follow our step-by-step guide to accurately calculate ARV:
Step 01: Assess the Real Estate Property
Start by determining the current value of the real estate property. You can either work with an appraiser or use online tools to evaluate the price of the property. You can also use the following factors to determine the value of the property yourself:
Location:
- School district
- Municipality or city
- Neighborhood
- Negatives in the area, such as junky neighbors, dangerous dogs, loud noises, smell, or power lines
- Attractive amenities in the community such as a cultural center, park, restaurant, ocean, gym, or lake.
Property:
- Condition of the property
- Garage
- Size (in square feet)
- Number of bathrooms and bedrooms
- Style – Ranch, modern, or bungalow
- Type – Townhouse, condo, house, duplex, etc
- Year of construction
- Finishes – Hardwood, granite, laminated, or vinyl
Lot:
- Fenced yard
- Major slopes
- Road traffic
- Interior or corner lot
- Landscaping
Step 02: Analyze Comparable Sales (Comps)
Now that you know everything there is to know about your property, look up recent sales of similar properties in the same neighborhood or nearby areas. These properties, also known as "comps," should be as similar as possible in terms of size, age, layout, and features to the property you're evaluating.
For instance, if you are buying a 3-bedroom and 2-bathroom house with a total square footage of 1800 square ft, look for at least three to five similar properties that have been recently sold or are currently under contract.
Here are three comps that you can use for this example:
Comp 1: 3 bed, 2 bath, 1,750 sq. ft. - Sold for $250,000
Comp 2: 3 bed, 2 bath, 1,900 sq. ft. - Sold for $275,000
Comp 3: 4 bed, 2 bath, 1,850 sq. ft. - Sold for $290,000
Step 03: Calculate and Adjust the Differences
In this step of calculating the ARV, you have to do thorough research on the features of all the comps and pick out the differences. The goal is to adjust the features to bring the comps as close to the subject property as possible.
Continuing the above-mentioned example, you just noticed that the subject property has 1800 sq. ft, which falls between Comp 1 and Comp 2. Because Comp 1 has the most similarities, we will use it as a base for the following adjustments:
Comp 1:
The subject property has an additional 50 sq. ft. compared to Comp 1. Considering $150 per sq. ft., the adjustment is $150 x 50 = $7,500 (Adjustment A).
We will add the sale price ($250,000) to calculate the adjusted differences with the adjustment cost.
Adjusted Price: $250,000 + $7,500 (Adjustment A) = $257,500
Comp 2:
The subject property has one less bathroom than Comp 2. Sarah considers a bathroom to be worth $10,000 in this market, so the adjustment is $10,000 (Adjustment B).
Similarly, the sale price for comp 2 was $275,000. Thus the adjusted price will be $275,000 - $10,000 (Adjustment B) = $265,000.
Step 04: Estimate the Value of Renovations and Repairs
To determine the ARV more accurately, you must consider the estimated cost of repairs or renovations needed for the subject property. Get detailed quotes from contractors or experts to assess the expenses involved in the necessary improvements and subtract the total renovation costs from the adjusted price calculated in Step 3. The resulting value is a preliminary estimation of the ARV.
The contractors give you an estimated repair cost of $40,000. Now, use the formula:
**The Current Value of a Property (or Average Adjusted Value of the Property) + Estimated Value of Repairs and Renovations = ARV
ARV = $261,250 + $40,000 = $301,250 **
Thus, the ARV of the property is approximately $301,250.
Another Way to Calculate ARV
If you don't have the time and resources to do a detailed analysis of all the comps, simply divide the selling price by their size (square footage). For example, the selling price of a 3000 sq ft comp was $300,000. Using the formula: 300,000 / 3000 = $100 per square foot.
Calculate the value per square foot for all the comps and find the average. Next, use the following formula to calculate the ARV:
ARV = Average Price Per Square Foot of the Comps x Size of Subject Property in Square Foot
ARV = 100 X 1,500 = $150,000
What Is the 70% Rule?
In real estate, the 70% rule serves as the standard formula used by investors, rehabbers, and property buyers aiming to determine the highest reasonable purchase price for a property, factoring in potential repair and renovation expenses. According to the general rule of thumb, one should avoid paying beyond 70% of the property's after-repair value (ARV), after deducting the estimated repair costs. The 70% rule formula is given below:
Maximum Purchase Price = (ARV x 0.7) – Estimated Repair Costs
Here's an Example:
Let's say an investor identifies a property in a desirable location with a lot of potential. After a thorough analysis and consulting with contractors, the investor estimates that the ARV of the property, once fully renovated, will be $300,000. The estimated repair costs are calculated to be $40,000.
Using the 70% rule, the maximum purchase price the investor should consider paying for the property would be:
Maximum Purchase Price = ($300,000 x 0.7) - $40,000 Maximum Purchase Price = $210,000 - $40,000 Maximum Purchase Price = $170,000
According to this aforementioned example, the investor should not pay more than $170,000 for the property to ensure a reasonable profit margin and account for any unexpected expenses during the renovation process. Sticking to the 70% rule helps investors in mitigating risks and making smarter investment decisions in the real estate market.
Even though the 70% rule is recognized as the industry standard, it is worth noting that certain rehabilitation specialists or wholesalers may opt to extend their investment up to 75%–80% of the After Repair Value (ARV) in order to gain a competitive advantage in specific market conditions.
What Are ARV Risks and Limitations?
Although estimating ARV is beneficial for investors, it does come with a set of limitations:
- ARV is an estimate and can change depending on the market conditions.
- ARV does not include underlying expenses such as finding mold within the walls.
- Requires a lot of time and money.
The Bottom Line
Property valuation isn't a skill that can be mastered overnight. Gaining expertise takes lots of practice and time. Using ARV (after-repair value) to determine the worth of the real estate investment after repairs and renovations have been carried out will help you make a smart and profitable decision and be a successful investor. Even though ARV is an ideal tool if you are flipping houses, it is essential to remember that after-repair value cannot be used to find the fixed or official price of a property. Instead, it is only an estimate evaluated using mathematical equations. The ultimate selling price of a property can vary depending on the variables used to calculate the ARV, the value of the current real estate market, and the renovation costs. if you want an idea of how much a potential investment property might cost you, ARV is the way to go.
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