This article is part of a larger series on Business Financing.
The after repair value (ARV) is the estimated value of a property after repairs and renovations are completed. It allows investors to determine a potential investment’s sales price, repair budget, and profitability. It is used when long-term investors estimate the long-term rental value of a property and when fix-and-flip investors buy, rehab, and sell properties for profit.
It also determines fix-and-flip investors’ maximum loan amount. These lenders tend to be hard money lenders that require purchase and renovation information in addition to personal investor information as part of the application process.
The after repair value formula is:
ARV = Property’s Purchase Price + Value of Renovations
Here are two examples of how to calculate ARV and how a fix-and-flip investor might use it:
- Example 1: A property is being sold for $60,000. The investor calculates it’ll take $38,000 to complete renovations, and area comps show the completed renovation could increase the value by $80,000 to $140,000. The ARV is $60,000 + $80,000 = $140,000. They stand to make a $42,000 profit. They would likely pursue this deal.
- Example 2: A property is being sold for $110,000. The investor calculates it’ll take $70,000 to complete renovations, and area comps show the completed renovation could increase the value by $70,000 to $180,000. The ARV is $110,000 + $70,000 = $180,000. This is the same as the potential sales price, so the investor wouldn’t be interested in this break-even deal.
How to Calculate a Property’s ARV
While the formula to calculate ARV is simple, coming up with the components for the formula isn’t so straightforward. Here’s what you need to do.
1. Estimate the Current Value of Property
The first step is to determine the current value of the property. Websites like Zillow and Redfin can be useful in determining the current property value. Your real estate agent will also have tools that can help determine as-is property value. Some of the factors that will determine the property value include:
- Location: Where the lot is located
- Lot: Size and shape, roads available to it, and so on
- Structure: Size, number of stories, type, and style
- Condition: How distressed the property is
2. Estimate Repair Costs & Value of Repairs
The process of estimating repairs is a two-step process. You need to know how much the repairs will cost and what the value added to the ARV by the repairs is. If you can spend $25,000 and add $50,000 to the ARV, that will increase the potential profit.
3. Find Comparable Properties
It is important to get an accurate estimate of the potential sale price of your completed project. To do that, you’ll need to obtain comparable values of other properties that have sold similar to your project. This will tell you if the project is going to be profitable.
Once again, your real estate agent can be a great resource when it comes to comparables. When looking for comparable properties, keep the following factors in mind:
- Properties must be within the same geographic area
- Properties must have been sold in the last 12 months
- Properties must be a similar size, with a similar number of bedrooms, bathrooms, and more
Comparables don’t have to be exactly the same as the property you are considering. An appraiser will add or subtract value from an appraisal to compare the two. For example, if one property has extra bedrooms or bathrooms, that will be added value. Zillow has an excellent resource on real estate comps.
Keep in mind that the more unique the commercial building you are buying, or the more remote area you are buying in, the much more difficult it can be to come up with accurate, comparable properties. This makes determining project profitability more difficult.
The 70% of ARV Rule
The 70% of ARV rule helps calculate the maximum bid price on fix-and-flip investments. It limits the bid to 70% of the expected sales price, minus repair costs. This allows investors to expect a 30% return on investment (ROI) if all goes well and provides a buffer for unexpected repair costs.
The formula for the 70% of ARV rule is:
Best Maximum Bid Price = (ARV x 70%) – Estimated Repair Costs
- Example: The ARV of a distressed property is $200,000, and it needs an estimated $40,000 in repairs. To calculate the best maximum bid price = ($200,000 x 70%) – $40,000. In this case, 70% of $200,000 is $140,000. Subtract the estimated $40,000 in repairs and the best maximum bid price is $100,000.
Drawbacks of ARV
While the ARV is one tool fix-and-flip investors use, it is far from perfect. There are several drawbacks to using ARV.
- Exact value of repairs is impossible to predict: While market data can help you get a good estimate on the value of repairs, it is hard to know exactly how much the repair will affect the ARV. This could result in a lower sales price after repairs, which could reduce your profit.
- Getting an accurate ARV takes time and money: Calculating all of the repair costs, added value, and comparable property values takes a significant amount of time to make sure you get it right. And it often takes the help of an expert, such as a real estate agent or certified appraiser. Using an expert will make the estimates more accurate but will cost you more money.
- Market fluctuations aren’t considered: The market has been very volatile over the past few years. While the commercial real estate market isn’t as volatile as the consumer real estate market, it can still fluctuate during the repair process, making the property’s final value different than estimated.
- ARV is subjective: In the end, whether it is repair costs, repair value added, or comparable property values, they are subjective values. You can make the best guess you can with excellent data and professional assistance from a real estate agent or a certified appraiser but, in the end, it’s not perfect. Therefore, fix-and-flip investors must be prepared for the risk involved with a potentially poor estimate.
If you purchase a distressed property, especially for a fix-and-flip investment, it is important to understand after repair value. It’ll help you know how much to bid on a project, how much repairs will cost, what value they’ll add to the project, and what the future sales price will need to be to profit.
The ARV is an imperfect tool, and it is important to know its drawbacks before beginning the process. Still, it can assist in determining the profitability and costs involved with a fix-and-flip investment. Investors, however, should also understand loan-to-cost (LTC) ratios and loan-to-value (LTV) ratios and how they impact a potential investment project.