What Is ARV: After Repair Value Formula & How to Calculate
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.
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ARV Formula
When calculating what is the ARV of a property, use the following formula:
ARV = Property’s Purchase Price + Value of Renovations
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.
Step 1: Estimate the Current Value of Property
The first step is to determine the current value of the property. Websites, such as 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 more
- Structure: Size, number of stories, type, and style
- Condition: How distressed the property is
Step 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. In other words, if you can spend $25,000 and add $50,000 to the ARV, that will increase the potential profit.
Step 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 will 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. You can also check out our guide on how to do a comparative market analysis for more information.
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
ARV and Maximum Bid Price Calculation Examples
Here are two examples of how to calculate ARV and maximum bid price and how a fix-and-flip investor might use it.
Example 1
Property Sales Price | $60,000 |
Estimated Repair Costs | $38,000 |
Projected Increase In Value After Repairs | $80,000 |
Amount Invested After Purchase & Repairs (Property Sales Price + Estimated Repair Costs) | $98,000 |
ARV | $60,000 + $80,000 = $140,000 |
Maximum Bid Price | ($140,000 * 70%) - $38,000 = $60,000 |
Potential Profit (ARV - Amount Invested) | $42,000 |
The investor stands to make a $42,000 profit, and the sales price is equal to the maximum bid price. They would likely pursue this deal.
Example 2
Property Sales Price | $110,000 |
Estimated Repair Costs | $70,000 |
Projected Increase In Value After Repairs | $70,000 |
Amount Invested After Purchase & Repairs (Property Sales Price + Estimated Repair Costs) | $180,000 |
ARV | $110,000 + $70,000 = $180,000 |
Maximum Bid Price | ($180,000 * 70%) - $70,000 = $56,000 |
Potential Profit (ARV - Amount Invested) | $0 |
The potential profit is $0, so the investor would not be interested in this break-even deal. For this deal to make sense, the property sales price would need to be equal to or lower than the maximum bid price, which is $56,000. The sales price of $110,000 is considerably higher, so this doesn’t make sense for the investor.
ARV Calculator
Benefits of ARV
Calculating the ARV can help both buyers and sellers of investment property. Here are some benefits of ARV:
- Determines future profit: By calculating the potential ARV and comparing it to the sales price, investors can determine whether a potential property will earn enough profit after a fix and flip.
- Sets the proper sales price: Once an ARV is calculated, sellers can set the right sales price for a distressed property to attract investors to buy.
- Forces cost-benefit analysis: By completing the ARV process, investors are forced to make thorough estimates of repair costs and potential value increases, which helps reduce the chance of making a bad investment decision.
- Allows investors to set budgets: By estimating the cost of repairs and the potential increase in value, investors can set budgets for construction teams to avoid overspends, which could cut into profit.
If you are looking for providers for fix and flip or hard money loans, you can check out one of our buyer’s guides linked below:
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:
- Is impossible to predict the exact value of repairs: 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.
- Takes time and money to get an accurate ARV: Calculating all 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.
- Does not consider market fluctuations: 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.
- 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.
Bottom Line
If you purchase a distressed property, especially for a fix-and-flip investment, it is important to understand ARV. It will help you know how much to bid on a project, how much repairs will cost, what value they will 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. Also, before getting a small business loan to purchase an investment property, it is important to understand the requirements lenders will have for this type of loan.
