ARV: Defined And Explained

Have you ever had the urge to flip a house, like so many on HGTV before you?

Real estate investment can be a creative and lucrative process when done correctly. As a first-time investor, however, you'll want to familiarize yourself with some essential terms before taking the renovation leap. The first (and arguably most important) term is ARV.

ARV can reveal a lot of information about the value of a property to both buyers and sellers, but what is ARV in real estate, exactly? We'll guide you through the process of calculating ARV and learning more about ARV real estate and its implications for house flippers.

What is ARV, exactly?

ARV stands for "after-repair value" and refers to the value of a home following repairs or renovations rather than in its current state. Real estate investors calculate it to ensure they get the most out of their investment property.

When real estate investors flip a house, they should carefully consider the return on investment with fixer-uppers. Considering the ARV helps determine their return on investment when they resell the property, renovations and all. It involves more than just considering the property's value as-is.

ARV benefits both buyers and sellers in the real estate market. It gives potential investors the background information they need to make educated decisions about the project's scope and the investment's value.

When trying to sell an investment property, sellers should also use ARV to determine the repairs that should increase its value for the buyer.

ARV works by looking at comparable properties, estimating renovation costs, using the ARV formula and ultimately deciding what repairs would be worth it.

To make the most out of a real estate investment, you can follow a few steps to calculate the after-repair value. It can help you ensure upfront that your project is worth pursuing.

Unfortunately, calculating ARV is more complex than plugging numbers into a calculator. It requires in-depth research into the surrounding area's property, repair costs and housing market. If you're considering buying a property, the following steps will help you determine the ARV and lower your investment risk.

1. Look At Comparable Properties

First, look at comparable properties (also called "comps") when calculating ARV. We recommend working with a real estate agent to get a comparative market analysis (CMA).

What is a CMA? Professionals in real estate use CMAs, which use the multiple listing service (MLS), a private database that lists data about homes in specific geographic areas, to gather the information.

CMAs can estimate the value of a home by comparing it to recently sold properties in the area based on the home's features and other factors, such as square footage, age, size, build and style. CMA reports typically help sellers price their homes on the market.

The CMA can help you determine the current value of a home before repairs.

2. Estimate Renovation Costs And Other Expenses

Next, estimate renovation costs and other expenses when calculating ARV. Getting an accurate estimate of these repairs from a licensed contractor will affect your ARV. In addition to obtaining the costs of your renovations, which might include installing new floors, replacing cabinets, removing broken and damaged structures, repainting and more, you can also calculate other costs for the following:

• Property taxes: Local governments levy property taxes on property owners within their jurisdiction or municipality for various taxpayer services, like road upkeep, school updates and more. You may also want to check in with county offices to learn more about property taxes.
• Insurance: Homeowners insurance involves the cost of insuring your home against hazards. You can estimate homeowners insurance based on replacement cost coverage – most insurance companies require homeowners to purchase replacement cost coverage worth at least 80% of their home's replacement cost.
• Homeowners association fees (HOA fees): Homeowners associations preserve the value of the neighborhood by monitoring the upkeep and quality of homes. They charge fees to maintain this upkeep, and depending on the area in which you choose, you will pay various amounts for your HOA. Find out from the HOA how much you'll pay for those fees prior to renovating a home.
• Utilities: The cost of utilities may take you by surprise. They may include things like telecommunications, electrical, natural gas and more. Ask a seller to show you recent utility bills and determine whether you will charge renters any of these expenses.

3. Calculate The ARV

Once you've assembled the above information, use the ARV formula to calculate your costs. ARV is equal to the price of the property you're considering renovating plus the estimated cost of the renovations involved:

ARV = Purchase Price + Value of Repairs

For example, let's say a home is worth $250,000 and the cost of repairs is $25,000. Note that the "purchase price" refers to the current value of the property. 

ARV = $250,000 + $25,000

ARV = $275,000

Note that you must be prepared for unexpected costs due to hidden damage, particularly in fixer-uppers. It's not uncommon for issues to appear "beneath the surface," such as treating for mold or termites. These or other issues can significantly change the renovation estimate of your property and potentially increase the ARV of your home.

Experts recommend following the 70% rule for flipping projects.

In other words, no purchase price at the beginning of a project should exceed 70% of the ARV minus estimated repair costs. Following this rule ensures that you'll make at least a 30% return on your investment:

Maximum Offer Price = 70% of the ARV - Repair Costs

Let's take a look at an example. Say a property has a value of $250,000 after repair and a contractor states that the estimated repair costs would be $50,000. In this case:

Maximum Offer Price = ($250,000 x 0.70) - $50,000

Maximum Offer Price = $175,000 - $50,000

Maximum Offer Price = $125,000

The lower the purchase price, the more potential you have for profit. Although the 70% rule is a standard real estate practice, some individuals may pay up to 80% of the ARV, depending on the housing market.

It's a good idea to consider both how to use ARV as well as the downsides to using ARV to determine the value of a property.

• Estimate only: It's important to note that the ARV is just an estimate. In other words, the appraiser could still determine that the home has a lower value than you anticipated. An appraisal means a professional appraiser goes through your home and property to determine its value, sometimes different from the listing price. The appraiser combines the information in a report and summarizes the home's appraised value. If an appraisal comes in low, a lender may not lend you the money to purchase the property – it will not lend more than the appraised value of the property. In this situation, you may end up with a home you may not want to complete repairs on in the first place.
• Doesn't account for changes: The ARV also doesn't account for changes in the housing market. The overall housing market contributes to property values. In other words, the number of properties for sale in the area and the number of buyers can affect the value of the home you're considering renovating. If many buyers compete for fewer homes, it's a seller's market. On the other hand, a market with few buyers but many homes is a buyer's market.
• Doesn't consider every angle: ARV doesn't take into account other factors involved in real estate, such as choosing the right location for your investment, considering factors such as desirability of where you live, schools in the area, crime reports, transportation available, potential for rent appreciation and more.

Now that you understand ARV meaning, you will likely realize how important it is before buying a home and completing renovations. 

It's a good idea to calculate the ARV of a home, or the value of a home after repairs or renovations, rather than in its current state. A real estate investor can help you determine whether you'll get a good return on your investment property.

Understanding ARV can help you avoid risky real estate investments and help you identify viable comparable properties. Using the 70% rule can help you learn more about your potential investment and its potential return.

Start the mortgage process today if you are ready to buy a home or become a real estate investor.