Why is ARV Important for Real Estate Investors?

Whether you’re investing in a fixer-upper or looking at your investment portfolio, it’s important to understand after-repair value (ARV). It’s a crucial concept in real estate investment and represents the value a property is estimated to have after it undergoes renovations and repairs.

ARV is a calculation that will influence an investor’s decision-making process and investment strategy, particularly if they’re invested in house flipping or renovating properties.

Before an investor can decide to commit to a property, they need to consider the ARV when determining the potential profitability of the property. The ARV will enable investors to determine if a property is likely to make a return on investment before spending time or money on it.

At Privy, our comprehensive real estate investing platform helps you find your next investment property. Our proven investor data, along with our intelligent filtering and comparative analysis, minimizes risk and maximizes profit on every investment. This guide takes an in-depth look at why ARV is important for real estate investors and how to calculate ARV.

What is ARV?

ARV is the projected value of a property after it undergoes improvements through repairs or renovations. The ARV acts as an indicator of what the property might be sold for after the construction work is complete. Calculating ARV enables real estate investors to determine if the renovation costs will deliver a feasible return on investment.

The ARV allows investors to ascertain a property’s potential profitability and develop their investment strategy. It is calculated by adding the current property value together with the value of renovations. This calculation is used to assess the feasibility of fixand flip projects, rental properties, and new investment strategies.

Calculating the ARV as part of a property evaluation enables investors to:

• Determine a budget for renovation costs
• Forecast what the property may sell for after the renovations are complete
• Identify the potential profit margins that can be achieved through a fix-and-flip property or rental property, allowing for better decision-making when developing the investment strategy and deciding on renovation costs

The ARV projects the value of a real estate investment, allowing investors to determine the feasibility and profitability of a potential project. Working backward from the ARV number enables investors to better account for renovation costs and other expenses.

Using ARV to Determine Feasibility

ARV allows investors to estimate the profit margin they can expect to earn from a property investment. Subtracting the purchase price from the proposed renovation costs will allow investors to better forecast their potential profit margin on a real estate investment.

It’s impossible to assess the viability of a property investment where renovations or repairs are required without considering the ARV. If you’re an investor interested in house flipping, ARV is one of the most important calculations to make for every property.

Identifying the ARV early on enables investors to secure the necessary financing for renovations and budget accurately. If an investor needs financing from a third-party or financial institution, they’ll often require an ARV calculation to assess feasibility.

With a fix-and-flip project, an investor’s goal should always be to make the property desirable instead of spending an unnecessary amount to overhaul it entirely.

How to Calculate ARV

Just like any real estate calculation, there’s more to consider than the basic formula.ARV is calculated by adding the current property value together with the value of renovations.

Investors cannot solely rely on this calculation as they’ll have to thoroughly evaluate the property’s current condition. It’s important to determine what repairs and renovations are necessary to bring the property up to market condition. Investors can also use tools like Privy to use comparable investment sale data for recently sold properties in the same area to set a ceiling for the renovation costs they can feasibly meet and still make a profit.

Similarly, ARV requires accurate estimates of the costs of the repairs and renovations. If an investor uses a significantly lower estimate, it may result in an ARV that is not an accurate forecast, setting unrealistic expectations. Therefore, most investors will seek professional appraisals to have a more accurate ARV calculation.

Step-by-Step Guide for Calculating ARV Rates

We’re sharing a step-by-step guide on how to calculate the after-repair value of a fix-and-flip property to determine if it’s worth exploring. While ARV appears to be a simple formula, it’s a more complex task that requires research on renovation costs, the local housing market, and the property’s condition.

1. Assess the current state of the property

The first step for any fix-and-flip property investment is to determine the property’s current condition. An investor may work with a contractor or professional surveyor to decide what work is necessary to bring the property up to market standard.

The cost of repairs and renovations can be less than most investors expect as the focus should be on improving the property to achieve a desirable state rather than extensive work that doesn’t add genuine value to the property or that would bring it over the market value.   

2. Estimate costs of repairs and renovations

An investor must have an accurate estimate of costs for repairs and renovations. Don’t work from an unsubstantiated figure. Investors should receive a professional report with itemized costs and estimates. 

3. Conduct a comparative market analysis (CMA)

After you have the proposed costs, it’s important to research the local real estate market. What do properties of a similar size sell for in that neighborhood or district? What renovations have been made for comparable properties? Understanding the quality of homes on the local market will determine what repairs and renovations are necessary to make the property desirable. Hot tip, Privy can do this instantly for you. 

Researching comparable properties in the local areas shows what you can expect to list your property for after renovations are complete. Determining the ARV enables investors to decide the maximum amount they’re willing to offer for a property to obtain the profit margin they desire. The 70% rule is often applied to fix-and-flip properties and should be considered when conducting a CMA.

4.   Calculate the average price of comparables

Following a CMA, an investor can calculate the average sale price for comparable properties. This figure determines a baseline to judge the ARV. Investors should also consider other costs related to the property when looking at comparable properties. Property tax, insurance, homeowner association fees, and utilities should be accounted for in the wider context of the ARV.

Investors should make reasonable adjustments for differences between their property and comparables, including factors such as size and condition. If a property has an additional bathroom, it will likely have a higher ARV.

5. Finalize the ARV estimate

After gathering all this information, an investor can finalize their ARV estimate. It should be based on the average price of comparable properties with adjustments made for relevant differences to determine a representative ARV.

What is the 70% Rule?

The 70% rule is a standard ratio that investors and lenders typically use when conducting a property evaluation. Under this rule, no more than 70% of the ARV should go towards repairs and renovations. Therefore, at least 30% of the investment should be made into the property itself.

The purpose of the 70% rule is to provide a cushion in the event of project delays, additional repair costs, and any unexpected challenges that may occur. The 70% rule ensures the investor can still make a feasible profit, even if these additional costs come up. Just like the 1% and 2% rules, the 70% rule should always be considered in the wider context of an investment strategy.

Importance of ARV in Real Estate Investment

Real estate investors who focus on fix-and-flip properties will use ARV calculations every time they assess a potential property. The after-repair value calculation will provide an estimate of the property’s market value after the repairs and renovations are carried out. The ARV will influence the price an investor offers on a property and their wider investment strategy.

If an investor is considering repairs on a long-term holding property, the ARV should still be considered. It can provide an estimate of the expected ROI they’ll earn from the repairs and renovations. If an investor is considering selling a property they hold, determining the ARV can help them decide if it’s the right time to carry out such work and put the property on the market.

Some repairs may significantly increase a property’s ARV for a smaller investment. However, other repairs may not increase the ARV enough to cover the renovation costs when considered against comparable properties. The ARV is important for risk management as it mitigates investment risks by providing the investor with a clear picture of potential returns.

Financial planning for fix-and-flip properties is only possible after an ARV calculation is carried out. Lenders will often require an ARV estimate to approve loans for financing repairs and renovations.

Factors Influencing ARV

ARV shouldn’t be calculated without considering the wider factors that will influence the valuation of a property. These factors are all aspects that an investor should consider when they’re developing an investment strategy.

These are some of the factors that will influence a property’s after-repair value:

• Property location: properties in high-demand areas and those considered up-and-coming will have a higher ARV as the location will be a major attraction for potential renters and buyers.
• Local market conditions: ARV should be considered in the context of the local real estate market with regional trends, including economic conditions that may impact the ability of a property to sell at its determined listing price. If the local real estate market is in decline, the ARV may be lower as a result.
• Property condition: The condition of a property will determine what repairs are required to bring a property up to market value. Extensive repairs may lead to a higher ARV.
• Future developments: Investors should always look ahead and consider upcoming infrastructure developments that may make the area more attractive in the future, such as schools, amenities, and commercial areas.
• Comparable properties: Investors should consider the condition of comparable properties to determine an accurate ARV estimate.

Considerations and Limitations of ARV

ARV is a tool every investor should use when assessing potential investment properties, but it’s worth acknowledging the limitations of these calculations. Here are three things to consider:

• Market fluctuations: The pandemic has shown how quickly the real estate market can fluctuate due to economic changes. An ARV calculation cannot account for changes in the housing market. Fluctuations in the local housing market also matter, such as the number of similar properties for sale and demand from potential buyers. If there’s a higher supply of houses than buyers, the market will be in the buyer’s favor.
• Missing factors: Investors cannot use an ARV as the sole instrument for determining if an investment will be profitable. An ARV cannot account for the potential for future rent appreciation and the desirability of a location.
• Only an estimate: ARV cannot be taken as a fixed figure. It is an estimate that should be used by an investor as part of their property evaluation. On a practical level, an ARV is required to access financing from financial institutes and third parties.