Real estate investing is full of industry-specific words and jargon. There are also a whole lot of abbreviations – and almost all of them are important. Terms like NOI and PCF are commonly found on websites and in books, but quite possibly the most commonly seem acronym when talking about flipping homes is ARV. If you’re first getting familiar with real estate investing, it’s one of the most important terms to not just learn, but also thoroughly understand.
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After Repair Value (ARV) Explained
In real estate, ARV is an acronym used to signify After Repair Value. This is the amount that, after being fixed up and remarketed, a property should sell for. Fixing and flipping are one of the investment strategies in which ARV plays a vital role in determining profits. By knowing how much a home could be sold for, you can determine whether or not it makes sense as an investment. ARV can be estimated by looking at local market events and comparing similar properties that have sold. If you’re working with a real estate agent, they should have the tools and knowledge to prepare a Comparative Market Analysis for you. You can also hire an appraiser, although this generally poses a significant expense.
The Importance of Proper After Repair Value Estimates
Calculating a potential investment’s ARV properly is a crucial first step in any fix and flip investment. The accuracy of your estimate is going to directly relate to how much profit you make on your deal. Overestimating value is just as large of a risk of underestimating costs and can lead to financial trouble just as quickly. Imagine, for a minute, that you’re planning to flip a home for $100,000 and, despite being over budget, you expect to earn $20,000 in profit. If your initial ARV calculation is off by just 10%, and your repaired property only works $90,000, your earnings were just slashed in half. Because of the impact of incorrect ARV estimates, it’s vital to be as accurate as possible.
Using ARV to Determine Your Offer
One approach to fixing and flipping real estate involves not calculating profit based on the purchase price and ARV of an investment, but instead determining your purchase price based on its ARV with your profit already worked in. The Maximum Allowable Offer (MAO) formula is a way to determine how much you can pay for a home in order for it to be a viable deal.
MAO = (ARV x .7) – Cost of Repairs
In order words, you can determine 70% of your ARV, subtract your estimate for repairs, and be left with the maximum price you should offer.
Say that in your search for a great deal you’ve come across a home for $70,000 that after $25,000 in repairs would be worth $130,000. That’s $25,000 in profit. According to the formula, taking into consideration the potential expense and sale price fluctuations, the most you’d want to offer for the property would be $66,000. Not only does this lock in an almost guaranteed profit margin for you, it also protects you against unexpected cost overruns or problems selling the home.
ARV Can Be Used when Wholesaling Too
The calculation of ARV is not limited to fix and flip real estate strategies. It should be used in any type of deal where repairs need to be done in order to bring the property up to its full potential. Another common strategy you’ll find ARV used a lot in is wholesaling. This is because, in many instances, you’re going to be wholesaling properties to other investors. In order to determine how much to offer on a contract in order to make your assignment fee, you have to know how much the final value to the investor will be. A great strategy is to modify the MAO formula slightly and also subtract your assignment fee after the expenses.
MAO = (ARV x .7) – Cost of Repairs – Assignment Fee
From the above example $130,000 ARV home, if you wanted to make a $5,000 assignment fee your maximum offer would be $61,000.
Having a good understanding of ARV is important to ensuring a healthy profit on your investments. If you’re not sure of how to accurately gauge the property’s future value, take the time talking with a real estate professional or an experienced investor that can help you out. With an accurate ARV estimate, you can not only determine a good offering price, but also minimize risk and help secure your financial future.