People and companies that buy houses, repair them, and resell them are called real estate flippers. If a flipper hopes to make any profit on a property, they must keep the amount they use to repair and buy the property lower than the selling price. This requires extensive knowledge of the real estate market in their area and an efficient way to estimate house values.
If you flip houses for profit, one of the best tools you can have is the experience in calculating the After Repair Value (ARV). This value ensures that you have something to show for your efforts after buying, renovating, and selling a home. But what is it, and how can you use it?
What Is the After Repair Value (ARV)?
The After Repair Value (ARV) in real estate refers to a property’s value after renovating it and putting it on the market that is arrived at by considering the estimated home value and repair costs. It is more of an educated estimate than a book value and requires that you be informed about the house you want to flip and its value after renovation.
How to Calculate After Repair Value (ARV)
Calculating the ARV of a property is quite simple, and you can do it if you have official figures from an appraiser. The formula is as follows:
After Repair Value (ARV) = Property Purchase Price + Renovations Value
The property purchase price is the amount at which you bought the house, while the value of the renovations is the value (exact or estimate) of the repairs you made on the house.
ARV — The 70% Rule
The 70 percent rule in real estate investing is a guideline that dictates that the bidding price on a property should never be more than 70 percent of the ARV less the estimated renovation costs. It can be represented as follows:
Maximum purchase price = (ARV x 70%) – Renovation costs
When followed, the 70 percent rule ensures that real estate flippers make at least a 30 percent profit on their investment. Some lenders also use the rule when determining how much money to lend a flipper for a project by calculating 70 percent of the ARV and making it the maximum loan amount. This application can be summarized as:
Maximum loan amount = ARV x 70%
This formula ensures that the borrowing flipper has enough to flip the house and that the lender will get their money back regardless of whether the flipper makes a profit or not.
Exceptions to The 70% Rule
When using the 70 percent rule, you should be cautious enough to make adjustments when dealing with very low or high-value properties. If a house has a very low ARV, you can maximize your profit margins by considering a lower purchase price. The lower purchase price will ensure you take home more than a few thousand dollars after the sale.
On the other hand, if the property is very high value, the 70 percent value may bar you from making an offer on the house. For example, if a house’s current market value is $500,000 with an estimated renovation cost of $90,000 and an ARV of $700,000, the rule says you should offer $400,000 for the house. It is unlikely that the property owner will accept a bid this lower than the asking price, even in its poor condition, which means you might have to increase the 70 percent mark to secure your bid.
Why Is ARV Important?
The After Repair Value (ARV) is most commonly used by flippers when determining whether to take on a project. It helps the flipper keep the renovations under budget so they can make a profit on their investment. Essentially, the ARV tells investors whether or not to invest in a property and, if so, the amount of profit they are likely to get. It is also used by investors who repair a property and rent it out rather than sell it for increased monthly returns.
How the ARV Works
The ARV formula remains constant except under the circumstances discussed under ‘Exceptions to the 70% Percent Rule,’ where you might have to adjust the variables. Besides the formula, using ARV requires that you establish the variables. You can determine a property’s current value by studying its condition, checking market listings, or hiring an appraiser.
Once you determine the current market price, you must make renovation estimates, which are the trickiest variable because not all damage can be seen until renovations begin. You can then use the 70% rule to establish your bidding price.
Finally, it is crucial that you study the competition to determine the hot properties in your area. This will help you determine your selling price after renovations.
Limitations of ARV
The ARV has drawbacks, one of which is its inability to factor in fluctuating market values. When established, the ARV of a property takes into account its current market value, which can change over time as market conditions shift and as renovations continue. Renovation costs, additionally, can vary as either more or less damage than estimated is found on the home.
Another limitation is the fact that appraisers, investors, realtors, and lenders may disagree on the value of a home. If the appraiser values the home at less than estimated at the time of reselling, the realtor will be forced to sell at that price, causing the investor to make a loss.
Lastly, the ROI for the flipper will ultimately depend on their negotiation abilities. Even if they use the ARV properly and estimate huge earnings, they could record a loss if they cannot convince buyers to purchase the home at their estimated value.
The After Repair Value (ARV) of a property is a crucial real estate tool for flippers or investors who buy, renovate, and resell homes. It is very simple to calculate and can mean the difference between recording a profit or breaking even and making a loss. When using it, it is important to remember that it is an estimate and not a book value, which means you should have a good grasp of local market values and conditions. You should also account for unforeseeable losses and repair costs.