When it comes to real estate investing, there is no shortage of acronyms. ARV in real estate or customarily known as After Repair Value is one that you’ll hear time and time again especially when analyzing a potential deal. But, what does ARV entail of and why is it so important? Let’s dive in deep into the world of After Repair Value (ARV) and explore the techniques that can help you make informed investment decisions.
ARV estimation is essential for maximizing returns and minimizing your overall risks when purchasing a fixer upper. I would even go out on a limb and say that if there is any skill that you must exercise continuously, it’s learning how to comp your subject property and accurately determine its ARV. So, let’s get started!
Understanding ARV in Real Estate and Its Importance
ARV, or After Repair Value, is the value of a property after it has been repaired or renovated. It represents the estimated market value of a property in its improved condition. Understanding ARV is vital because it allows you to gauge the profitability of your investment. If you intend to keep the house as a rental, knowing your ARV can help you limit how much capital remains in the deal when you refinance after renovations are completed.
Case Study
Pairing the ARV and the cost of repairs associated with a property should also determine how much you actually pay for a fixer-upper. When determining your max allowable offer, it’s generally a good practice to first start with your subject property’s ARV and a ballpark figure of the repairs needed. Let’s run through a quick example:
Let’s say you’re looking to flip a house that would have:
An After Repair Value (ARV) of: $250,000
Estimated Repairs of: $50,000
How much should you pay for this house?
Let’s take a deeper look:
Let’s assume that the hard money lender will lend a total of 75% of the ARV between construction and acquisition of the home on a fix and flip loan. To determine the total loan amount, we would multiply our ARV by the lender’s max loan to value (LTV) in this case it is 75%:
$250,000 x 75% = $185,000
Now, to ensure that we are purchasing a good deal with a healthy profit margin, our purchase price and repairs should not exceed $185,000. To determine the max allowable offer for this property, we would then subtract the estimated repair costs (in this case $50,000) from the max loan amount:
$185,000 – $50,000 = $135,000
In this scenario, $135,000 should be the max purchase price you are willing to pay to ensure that your flip yields a healthy profit margin. As you can see, the max allowable offer in this scenario takes into consideration the repairs and max loan amount which is all derived from the subject property’s ARV.
Now, let’s take a look at what factors may affect your ARV and methods for estimating your ARV.
Factors Affecting ARV in Real Estate
When estimating ARV in real estate, several factors come into play. Location, overall condition, size, amenities, and market trends all impact the property’s value. All of which will be very market specific. For instance, a property located in a desirable neighborhood with an excellent school district will likely have a higher ARV compared to a home situated next to an industrial influence such as a landfill and a busy road.
This method of valuation is known as the sales comparison approach and as you can see, it plays a vital role in ARV estimation. But when selecting comparable homes, it’s important that they are selected within close proximity to the subject property. What is considered as being in close proximity? As a rule of thumb you can follow these tips:
- Urban Area: Within ½ mile of the Subject Property.
- Suburban Area: Within 1 mile of the Subject Property.
- Rural Area: Within 5-10 miles of the Subject Property.
Now, keep in mind that these are just guidelines, depending on your area and market activity you may need to adjust your search criteria accordingly.
Methods for Estimating ARV in Real Estate
Now that we understand the importance of ARV and the factors affecting it, let’s explore different methods for estimating ARV in real estate.
Comparative Market Analysis (CMA):
This method involves analyzing recently sold properties in the area that are similar to the subject property. By comparing their sale prices and adjusting for differences, you can estimate the ARV. It’s essential to consider properties with similar characteristics, most notably similar square footage, condition, and location.
Appraisal:
If you’re purchasing a distressed property using a fix and flip loan, the lender will order what is known as a prospective appraisal. This appraisal will provide two valuations; the current value and the after repair value. The lender will determine the total loan amount based on the after repair value that the appraiser assigns to your property.
As mentioned before, the appraiser will more than likely use the sales comparison approach to determine the ARV. When selecting comparable properties to determine the ARV, the appraiser will use the construction budget you submitted to the lender and select comparable sales that feature the same grade and quality of finishes noted in your rehab budget.
Online Valuation Tools:
Numerous online platforms offer property valuation tools that use algorithms and data analytics to estimate ARV. These are known as AVM’s or Automated Valuation Models. One of the most popular AVM’s (and probably the most criticized) is Zillow’s “Zestimate”. While these tools can be useful for getting a rough estimate. It’s important to remember that they are not always 100% accurate. AVM’s will tend have better reliability if there are a lot of sales and market activity. A good example would be in a neighborhood or subdivision with homes that are similar in nearly all of their characteristics. Like townhouses or spec-built tract homes. All in all, online valuation tools should really only be used as a starting point and complemented with other methods for a more comprehensive estimation.
Gathering Data and Conducting Comparative Analysis
To determine the value of the property accurately, you need to gather relevant data and conduct a comparative analysis. Start by collecting recent sales data of similar properties. Zillow and Redfin can be a great source to find recent sales records. However, if you can muster up a way to gain access to your local multiple listing service (MLS) you will fare better. MLS records tend to have more information that can help you determine your ARV more accurately. If you live in one of the 12 non-disclosure states, MLS records may be your only option.
Generally, you should select at least 3 sales to come up with a reliable after repair value. Take note of any differences in size, condition, and amenities. If necessary and justifiable, you may need to adjust the sale prices based on these differences to arrive at an accurate ARV. Adjustment figures will vary depending on your location and are determined by conducting what is known as a “Paired Sales Analysis”.
Paired Sales Analysis
A Paired Sales Analysis is a technique for estimating the value of an element like an additional bathroom or the number of bedrooms. The theory is that if two houses are identical except for one feature. Then that one feature is the reason for any value difference.
So as an example, I purchase and renovate distressed homes in the Philadelphia area. A home with 1 full bathroom vs 2 full bathrooms will tend to have a $5,000 difference. So if I was trying to determine the ARV of a home I’m buying that has 2 full bathrooms. But, a comparable I found only has one full bathroom, I would adjust that comparable up by $5,000. When a comparable has an inferior feature, you adjust upwards (add). If a comparable has a superior feature, you would make a downward adjustment (subtract). One easy way to remember this is to keep the acronyms CIA and CBS in mind:
CIA = Comparable Inferior Add
CBS = Comparable Better Subtract
Refining ARV Estimates and Mitigating Risks
While ARV estimation is an essential skill, it’s crucial to refine your estimates and mitigate potential risks. Here are some strategies to help you along the way:
Consult with Professionals: Seek guidance from experienced real estate agents and appraisers who have in-depth knowledge of the local real estate market. Their expertise can provide you with valuable insights and help you refine your ARV estimates.
Consider Property-Specific Factors: Analyze property-specific features that can impact value, such as unique architectural features. Ideally, you should be comparing apples to apples (i.e. similar condition). In a lot of markets a ranch style house may not sell for as much as a colonial styled home. Whereas, in other markets, architectural style may have no or minimal impact on sales prices. Thinking of using an attached townhouse as a comparable for a detached tudor style home? You may want to think again unless you have a solid grasp on the adjustment you would need to make. It’s almost always a better idea to select a comparable that looks like your home.
Thorough Research and Due Diligence: You should conduct extensive research on market trends, economic indicators, and neighborhood developments. Staying informed about upcoming projects or changes that could affect property values will ensure that you’ll make an informed decision and mitigate risks altogether.
The Wrap Up
Now that you’ve grasped the importance of ARV in real estate, considered the factors that impact it, and explored various estimation methods. You’re ready to make smarter acquisitions and increase your profitability. Remember, gathering relevant data, conducting comparative analyses, and seeking guidance from professionals with local expertise can make all the difference. With practice and experience, your ARV estimation skills will become sharper. Therefore allowing you to spot hidden gems and avoid potential pitfalls. So, keep honing your skills, and let ARV be your compass on the road to success!
