In this article, we will explain ARV and how you can use it to ensure profitability in a future real estate deal.
What is ARV?
ARV is the estimate of a property’s value after all repairs and renovations are finished.
Through determining the ARV of a property, real estate investors will know the max offer price based on the margin that they need to make and can submit a strategic offer to the seller.
Knowing ARV can also help you adjust the asking price of the property when you have finished the repairs and you are ready to sell the property.
Simply put, ARV takes the guessing out of a real estate investing deal so that you don’t lose money.
How Is ARV Calculated?
ARV is calculated using the following formula:
Purchase Price + Value From Renovations = After Repair Value
In order to determine the value from renovations, many real estate investors use “comps”, or comparable properties in the surrounding areas.
Next, we’ll look at each step in depth.
To calculate the ARV of a property, you have to first estimate the current value of that property.
A professional appraisal service can identify any issues that may depreciate the property value. A look at the property on the MLS is another tool to utilize.
It’s also important to carry out a comparable market analysis.
Try looking for comps located close to your property, same size and age of your property. You can also compare your real estate property with others that were sold within a two to four months period so you can see how your property compares in terms of value.
This current value will dictate the purchase price of the property.
Value From Renovations
After estimating the property's current value, the next step is to estimate the value from renovations.
This starts with estimating the repair cost on the property. To make a profit on the property, the total repair cost must not be greater than the value of renovations once complete.
After you have both the purchase price and the value from renovations, you can determine the after repair value.
What Is The 70% Rule In Real Estate Investing?
When you're rehabbing a property, taking into account the repairs you make on the property prior buying and reselling it is critical.
This is where the 70% rule comes in. It helps investors determine their maximum offering price.
The 70% rule stipulates that a real estate investor should not pay more than 70% of the after repair value (ARV), minus repair costs.
If a real estate investor invests more than 70%, and there is a change in the market, he or she could either be unable to sell the property, or have to sell it for far less than they originally put into it.
For example, if a property has an after repair value of $300,000 and the estimated repair costs are $50,000, then:
$300,000 x 70% (ARV)
- $ 50,000 (estimated repair cost)
$ 160,000 (maximum offer price)
Benefits of ARV
The ARV of a property is an important factor when investing in real estate. The benefits of ARV include the following.
ARV enables you to set a price for an offer
ARV real estate plays a significant role in allowing a property owner to set a price for an offer from a real estate investor.
Knowledge of ARV would help the seller provide an estimate for renovating a property before setting the total cost of the property.
ARV is essential to helping you get your desired profit
With a proper ARV calculation, a seller can place a price tag for a property and still maintain a profit margin even after considering repairs.
It also assists real estate investors in estimating how much they may gain from going ahead with the deal.
ARV reduces risk
Calculating the ARV of a property can help to reduce the risk of losing money when flipping houses as an investor.
A proper ARV calculation will give real estate investors an idea of what to expect.
Risks/Limitations of ARV
It’s important to keep in mind that there are limitations to the ARV of a property.
Changes in the Market
If housing market conditions suddenly change while a real estate investor is in the middle of a project, the ARV will most likely change too.
The true ARV of a property is what someone else is willing to pay for it, and the price is determined by the market. The real estate investor determining the ARV does not set the price according to his or her determination.
An investor could pull the best comps and have back ups to support a value but if no one is willing to purchase the property for that price, the investor will have to drop their price to the market value.
Underestimated Repair Costs
Also, if you underestimated repair costs or chose poor comps, your estimation of a likely sales price could be far different than it should (for example, much more expensive), making it hard to sell the property.
ARV for Wholesaling
ARV isn’t just a tool for those looking to fix and flip a house; it’s also an important tool for wholesalers.
As a wholesaler, you buy a property under contract to sell to a real estate investor without carrying out any repairs on the property.
To know how much a buyer is willing to pay for your acquired property, you as the wholesaler must calculate the after repair value of that property.
The Bottom Line: After Repair Value
After repair value is a critical calculation all real estate investors should be familiar with.
By knowing the term, and more education, you can set yourself up for a profitable real estate deal — and minimize risk.
If you’re looking for additional ways to maximize your profit margins and minimize risk, here are additional real estate tools:
- Learn how to calculate gross rent multiplier to determine the profitability of a rental property
- Use this thorough rehab checklist to renovate a property and increase it’s value
- Discover how to pay less taxes legally on your rental property using these strategies
- Learn what cash on cash return is for real estate investors