Master Guide to After Repair Value (ARV)

“After Repair Value” (ARV) is a critical concept in real estate investing, particularly in the context of flipping houses or rehabilitating properties. It refers to the estimated market value of a property after it has undergone necessary repairs and renovations.

Understanding ARV is essential for investors to make informed decisions and to ensure profitability in their real estate ventures.

Definition and Importance of ARV

• Definition: ARV is the projected value of a property after it has been improved or renovated. This value is an estimate of what the property can sell for in the current market after all the planned work is completed.
• Importance in Real Estate Investing: ARV is crucial for investors who engage in buying properties that need work, fixing them up, and then selling them for a profit. It helps in determining the potential resale value of a property and plays a significant role in making investment decisions, setting budgets for renovations, and securing financing.

How ARV is Determined

1. Comparative Market Analysis (CMA): This involves looking at similar properties in the same area that were recently sold, preferably post-renovation. These comparables, or “comps,” help in estimating the potential selling price.
2. Assessment of Required Repairs and Improvements: Evaluating the extent and cost of necessary repairs and improvements is vital. This assessment should be thorough to ensure that all aspects of the renovation are considered in the ARV.
3. Professional Appraisal: Sometimes, investors may seek a professional appraisal to get a more accurate estimate of the ARV, especially for unique properties or in complex market conditions.

How to Calculate ARV

Calculating the after repair value is very similar to doing a comparative market analysis. There is one important difference though.

When determining the ARV, you will be using your subject property, but using hypothetical information based on the upgrades you will be performing. This is because repairs and upgrades haven’t been made yet.

You do this by taking the current value then adjusting it by the value of upgrades, which are determined using the CMA method.

Estimating the Value of an Upgrade

Let’s use a hypothetical 3 bedroom, 2 bathroom, 1,250 square foot house that is worth $125,000 in its current condition. You want to know what the property would be worth if the kitchen and bathrooms were upgraded.

Step 1) Find several similar properties with a few that have no upgrades and a few that have the upgrade you’re looking for.

Step 2) Make any adjustments for any other differences.

Step 3) Take the average price for each group of houses.

Step 4) The difference between the two is the value of the upgrade.

Example of Estimating the Value of an Upgrade

We found 3 great properties that are in a similar condition to our subject property. We also found 3 that have upgraded kitchens. Let’s compare

Basic Properties:

1. $124,000
2. $126,500
3. $125,750

Average – $125,416

Upgraded Properties:

1. $145,000
2. $142,000
3. $149,000

Average – $145,333

To estimate the value of this upgrade just subtract the two.

$145,333 – $125,416
Value of a New Kitchen = $19,917

Calculating the ARV

Once you have a list that estimates the value of each upgrade, you can just add them together.

Current Value – $125,000
New Kitchen – $19,917
Bathroom – $4,570
Estimated After Repaired Value – $125,000 + $19,971 + $4,570

ARV = $149,541

The Role of ARV in Investment Strategies

• Flipping Houses: For house flippers, ARV helps in determining the maximum purchase price they should pay for a property to ensure profitability. The formula often used is: Max Purchase Price = ARV – Repair Costs – Desired Profit – Other Costs (like transaction fees).
• BRRRR Strategy (Buy, Rehab, Rent, Refinance, Repeat): In this strategy, ARV is crucial for the refinance phase. A higher ARV can lead to better refinancing terms, allowing the investor to recover a significant portion of the initial investment.
• Securing Financing: Lenders often consider the ARV to determine the loan amount for fix-and-flip projects. A higher ARV can lead to more favorable lending terms.

Is an Upgrade Going to Be Profitable?

At the most basic level, we can compare the increased value to the cost of upgrades to determine if it’s profitable. If the project cost is $20,000 and the value of the house is expected to increase by $24,541 then we can estimate that you will have created almost $5,000 worth of equity.

With this sort of granular level data, you can dig very deep into your project to determine which upgrades you need to perform and which are not worth it. We know that kitchens generally have the highest return on the upgrade, so let’s dig really deep into that.

You may be looking at two possible kitchen designs for this house, a premium and an average level. With the premium upgrade package, you would put in better cabinets, appliances, and countertops than the base level. But there are obviously different costs involved.

The quotes from your contractor are:

Base Level: $15,000
Premium Level: $25,000

Will the better quality kitchen give us better or worse returns?

Upgrades Should Match the Market

Not all upgrades are going to be profitable. Many people over or under improve a property.

You might be wondering what it means to over-improve a property. To understand this, we need to understand the psychology of shopping.

Perhaps you want to buy a car. You need it to get to work and a few places around town, but that’s all. You don’t want something fancy to get these things done.

When shopping, you find a slightly used car without many features, and it’s selling for $10,000.

You also find another slightly used car, but it’s the top trim package and is selling for $25,000.

While the more expensive car is clearly much better, you just need it for some basic usage. Would you pay the extra $15,000 for the car?

A house is similar, especially this 1,250 square foot starter home for $125k. This house is like the base package for the car – it has few amenities or upgrades because the buyers don’t need them and aren’t willing to pay for them.

Doing the crazy kitchen remodel might make the house sell for far more, or the buyers aren’t willing to pay that premium for that upgrade.

Comparing Upgrades to ARV

So, it’s important to check the value of the upgrades for each house and area because nicer upgrades are not always better.

Continuing this example, you can do two sets of analyses to determine the value of the kitchen upgrades. The first one you already did and the kitchen upgrade adds $19,971 to the value of the house.

And let’s say the nicer kitchen adds $27,000 to the value of the property. Now it’s time to compare. Since we are looking to make a profit, we want to see which one makes more profit for us which is value – cost = profit.

Base Upgrade Profit = $19,971 – $15,000 = $4,971
Premium Upgrade Profit = $27,000 – $25,000 = $2,000

Based on our numbers the base upgrade package is actually more profitable for this particular house. If we were looking at premium quality houses, then the answer would be different. But for this starter-home, the base package is better.

How to Use the After Repair Value When Making Offers

You will want to make an estimate of ARV any time you plan to do work on a property. Generally, when we purchase property, we plan to make upgrades. So, determining the ARV should be part of every transaction you are ever involved in.

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.

So Purchase Price – Profit Margin
$160,000 – $10,000 = $150,000

Now deduct fees, closing costs, attorney costs etc… To make it easy, say it’s an even $10,000 also.

$150,000 – $10,000 = $140,000

So far we can offer $140,000 and break even. But we aren’t in business to break even so let’s continue.

You plan to do a ton of work on it. Your contracts quoted you $35,000 and you add $5,000 for contingency expenses. $40,000 total

$140,000 – $40,000 = $100,000

Based on this simple example, our offer price should be no higher than $100,000.

That seems a little too simple… right?

Well, we can get more complicated and factor in some additional unexpected costs or reduce the estimated sale price to give us more margin. But, we’re keeping it simple for illustrative purposes. But, this is truly how simple the process is.

Limitations and Risks

• Market Fluctuations: The real estate market is dynamic, and changes in the market can affect the ARV. Economic factors, interest rates, and local market conditions can all influence the final selling price.
• Estimation Errors: Incorrect estimation of repair costs or overestimating the ARV can lead to financial losses. It’s crucial to be as accurate as possible in these assessments.
• Unforeseen Complications: During renovation, unexpected issues may arise, leading to increased costs and potentially affecting the ARV.

Your Exit Strategy Affects What You Will Pay

The example above has been for a flip, so, 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 definitely make this a bad deal for any house flipper.

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.

Knowing After Repair Value

Understanding the After Repair Value is fundamental for real estate investors, especially those involved in property flipping and rehabilitation. It provides a framework for estimating the potential return on investment and aids in making strategic decisions. However, it’s important to approach ARV calculations with diligence and to be mindful of the various factors that can influence the final value of a property post-renovation.