After repair value is one of those terms you’ll hear tossed around on a daily basis.
Without understanding ARV, you probably won’t be successful for very long as a real estate investor.
So, embrace it, learn it, and love it.
What is After Repair Value and How do I Calculate It?
In order to learn how to calculate the ARV, first, we need to know what it is.
After Repair Value Definition
After Repair Value is the estimated value of a property after all necessary repairs have been made, deferred maintenance has been corrected, and major upgrades or renovations have been finished.
ARV is an estimate made before the property sells. Once the property is sold, the selling price is the actual market value.
How to Calculate ARV
Calculating the after repair value is very similar to doing a comparative market analysis.
Really, calculating ARV is exactly like doing a CMA, except it’s done with a hypothetical property (since repairs and upgrades haven’t been made yet) rather than the actual property.
So, go check out the article on CMAs first, then come back.
Let’s say that you are considering buying a 3 bedroom, 1 bathroom home that is 1,200 square feet. It’s in livable condition, but it’s not great.
To calculate its value, you run the comps and figure out it’s worth $120,000.
But you aren’t going to leave it in its current condition; you plan to do some work and improve it.
You plan to renovate the kitchen, bathroom, and add another bathroom. When you are done, it will be a 3 bedroom, 2 bathrooms, 1,400 sf home (it’s larger because we are converting non-living space into a bathroom).
So, you need to do a new CMA. You will see what other 3/2 properties with all the best upgrades are selling for. You also need to look at properties that are a bit larger than your original target.
Let’s say the CMA shows this improved property is worth $160,000
How to Use the After Repair Value When Making Offers
The purpose of estimating the ARV is to help you work backward and determine exactly what you are willing to offer.
Example: Using ARV to Determine an Offer
Let’s use the numbers above and say you found a property that you think will have an ARV of $160,000.
Now let’s work backward to determine your offer price.
First, deduct your profit goal from the number. Let’s use an even number of $10,000.
That give us $150,000.
Now deduct fees, closing costs, attorney costs etc… I’ll just say $10,000.
That gives $140,000.
You plan to do a ton of work on it. You’ll need to estimate the repair costs, but, for simplicity, let’s say repairs will cost $40,000.
We’re at $100,000 for an offer.
That seems a little too simple… right? Well, I’d take it a step further and build in some unexpected costs.
I might take 10% off the estimated value or add 10% to the estimate costs, or both.
But you get the idea.
The 70% Rule to House Flipping
There is a “rule of thumb” that many real estate investors use to determine their offer prices.
It’s called the 70% of ARV rule.
Like any other rule in real estate, it is more of a guide than a rule.
All the rule states is that you should never pay more than 70% of the ARV, once accounting for repair costs.
With the example above, 70% of $160,000 is $112,000.
Now subtract the repair costs from that ($112,000 – $40,000) and you get $72,000.
Why is the 70% rule so different from the example?
You probably noticed the answers are dramatically different in the two examples.
It’s because in the first example I didn’t build in any margin for error. If you took 10% off the ARV for safety and added 10% to the repair costs, you’d get an offer price of roughly $80,000.
The 70% is a bit more conservative than that and probably accounts for a little bit higher profit margin, but at least they are close.
The 70% Rule is Meant to Be Broken
Every market is different and this “rule” is just a guideline.
A highly competitive market may require your “rule” to be more like the 80 or 85% rule. A less competitive market may allow you to go even lower than 70%.
So, don’t just take this rule and assume it’s the answer. You really need to look at your market and estimate a ton of deals before you get an idea how competitive it is.
Your Exit Strategy Affects What You Will Pay
The example above has been for a flip. What if you plan to keep it? Should you pay more for a property you want to keep for a while instead of flip?
The answer is: absolutely.
Landlords are generally willing to pay a bit more for a property than a house flipper because landlords take a long-term approach.
I’m not saying you should pay more for a property than you need to, but it’s completely realistic to say that your goals affect your strategy.
Let’s take the example above and say you couldn’t get your offer price, but you could get it for $10,000 more.
That would completely wipe out the estimated profit. It would be a deal killer for sure.
But, $10,000 is only about a $50/month difference on the mortgage. The landlord can almost definitely absorb that cost and still have solid cash flow on the property.
The landlord may also benefit from appreciation in the property if the market appreciates over the holding period.
The key to being successful: know your numbers and see how they relate your goals and strategy.