Make Smart Real Estate Investments
Understand how to use the After Repair Value
to maximize the ROI of your house flipping strategy
Image courtesy of BiggerPockets (2017)
One of the most common formulas used by investors in residential real estate as well as their lenders is the ARV aka the After Repair Value.
Simply defined, ARV is what a property will be worth when the rehab is completed. Not only the ARV is important to assess the expected profitability of an investment, it is also favored by lenders to determine the maximum loan amount that can be granted against a given investment property.
Here are the 3 things you need to know the ARV:
How to Calculate the ARV
The formula used for the ARV is very straightforward: It is the ratio of the purchase price with repairs over the estimated value after repair value. It is usually referred to as a percentage, so do not forget to multiply by 100.
In order to assess the value after repair, the starting point is comparable sales over the past 6 months for homes similar to the investment property in terms of square footage, bedrooms, bathrooms and location but also in a similar condition.
How to Assess the Scope of Repairs
As for conventional home purchases, a comprehensive home inspection will provide guidance about the type of repairs required or recommended based on current market standards. The inspection report will also help determine if the rehab is mostly of cosmetic nature or requires extensive remodeling.
The next step is to get at least 2 quotes from distinct contractors who are familiar with the type of repairs that need to be made. Keep in mind that even with the most experienced rehabers, repair costs often go over budget, so plan to set aside extra money.
Remember that “putting lipstick on a pig” rarely pays off as true investors will see through and most likely will come up with low ball offer, in the knowledge that they will need to undertake additional repairs.
What is the Right ARV Ratio
Typically a 60% ARV ratio is the sweet spot for many investors. 65% -70% is a more realistic based on closing costs both ways, holding costs (such as property tax, maintenance costs) and financing costs (depending whether you use a private or a hard money lender).
The ability of your realtor to sell, advertise and negotiate with prospective buyers on your behalf may also drive up or down the ARV ratio.
At the end of the day, the ARV is only one way to assess the validity of an real estate investment. Remember that, if the property is worth it, do not hesitate to go the extra mile as home buyers are often prompt to spend extra money for a property renovated with care which addresses their basic and inner needs.