Why ARV Is the Most Important Number You Need to Know
One of the best ways to make money in real estate is to add value to a distressed asset. This can take many different forms, but rehabbing a property is one of the main ways to increase a property’s value.
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That said, it's extremely important to be able to accurately measure what the future sales price is likely to be post-renovation in order to ensure a property will generate enough margin to be profitable. This is where ARV comes in.
What Is ARV?
ARV stands for after repair value. Simply put, what is the worth of a property after value is added?
If you’ve been on BiggerPockets for any amount of time, you’ve probably seen or heard the term thrown around quite a bit.
Why Is ARV Important?
ARV is important for a couple different reasons. Let’s dig into two of them.
1. Flipping Houses
The ARV is critical to your success if you're flipping a house. If you don't know the after repair value, then you probably shouldn't be flipping it in the first place. You need to know what the sale price of the property is before you even swing a hammer. We'll dig into an example later on.
2. Calculating Equity (a la BRRRR Strategy)
If you're rehabbing a property to keep as a buy and hold, it's still very important to know your ARV. Why? Because you'll want to know what your equity position is. This is critical if you plan to BRRRR the property—meaning buy, rehab, rent, refinance, repeat.
If you are buying in cash and plan to put a mortgage on the property after it’s stabilized, then your ARV is your best friend (or worst enemy). This helps you answer how much money will need to be left in the deal or how much money you can take out in order to move on to the next one. Just like the flip, we’ll offer up an example in a bit.
How Do You Calculate ARV?
So, how does an investor calculate an accurate ARV? There are a few ways to do this.
1. Use a Realtor
An experienced Realtor will have a good handle on values in a given market. Most will know a value just by glancing at a property. Just make sure they actually are experienced and have a good track record.
You can easily test them over the phone: “Hey, what did 123 Awesome Street sell for last month? That looks pretty close to the square footage and style that we’re looking to buy.”
If they balk or aren’t familiar with the location or property, you can confidently move on to someone else.
When I was an agent, I was able to at least give a solid estimate of properties in our town based on the street or neighborhood. A good agent will know what houses are selling for, especially on a square footage basis.
Realtors can also give you comps, also known as comparables, which is really helpful. This way you can see pictures of sold properties, descriptions, price per square foot, etc., enabling you to compare apples to apples as much as possible.
2. Use the Internet
As you’re probably aware, you can find data on the internet. Lots of data. Sites like Zillow, Redfin, Realtor.com, and more have thousands of sales in their databases. It’s not that hard to get your own comparable properties online and do the homework yourself.
3. Dispassionately Calculate the Data
Everyone wants to reach for the moon when it comes to their own valuations. Don’t do that. Be as unemotional as possible when looking at the data. This can save you from buying a bad deal and help you get the most possible in a good one.
Evaluate the properties in question and see why they sold. Was it the location? The amenities? The school district? All of the above? When you’re planning out your rehab (or even just the purchase), keep these things in mind.
How to Protect Yourself From a Bad ARV
A misguided ARV will sink you. Whether it’s a flip or a rental, if you’re off on this number, it’s going to hurt. So, how do you protect yourself from a bad ARV?
Aside from following the tips outlined above, make sure that you’re not overvaluing your rehab. Many real estate investors make this mistake.
“But it’s brand new! A complete gut!”
That doesn’t matter as much as you think. When it comes down to it, a buyer is usually going to finance a property and that means the bank will require an appraisal.
Why Appraisals Matter
When calculating what properties are worth, it's prudent to evaluate it from the perspective of a real estate appraiser. They are the gatekeepers when it comes to getting a transaction pushed through. If a property value doesn't jive with the contract price, it can cause big problems—for both the buyer and the seller.
Especially on flips, it might be worth hiring an independent appraiser prior to selling (or even rehabbing) to get a realistic value of the ARV. Of course, appraisers have also been known to make mistakes, so take everything with a grain of salt.
This can be a powerful sales weapon for you though. If you’re thinking of pricing the property at $250,000 and the appraiser says it will be worth $260,000, your marketing campaign just got a gift. You can market it at $250,000 and say it’s priced $10,000 under appraised value. Buyers love a deal.
Double-check Your Agent’s Work
Make sure you don't accept your Realtor's ARV at face value. Do your own due diligence. They can be wrong too (valuing under or over), so make sure you're looking at their guidance with a critical eye.
Examples of How NOT to Calculate ARV
Miscalculating ARV on My First Flip
I was an agent at the time. I found a foreclosure and purchased it for $115,000. It needed a $65,000 rehab. Given the neighborhood, I thought I could fetch $235,000 for the house after we were finished. I was fairly close to that number, and we went under contract with a buyer for $230,000.
Things were looking good until the appraisal was done. It came in a whopping $30,000 under the contracted price. This meant that if we accepted the appraisal, it would wipe out most—if not all—of our profit.
We contested the appraisal and asked for a new one. No luck.
We ended up renegotiating with the buyers and settled on a price far below what was contracted but more than what the appraisal came in at. At the end of the day, we made money. But it was certainly a challenging first flip!
Miscalculating ARV on My First Rental
This was an auction property I bought with my buddy (and business partner). Our intent was to employ the BRRRR method so we could move our funds on to the next property as quickly as possible. I was planning on an ARV around $145,000-$150,000.
We bought it for $62,000, rehabbed it for $62,000, and it appraised for $150,000. This was obviously not a perfect BRRRR, but it did set us up for success as we purchased more rentals over the next few years.
ARV During a recession
Since it seems we’re heading toward a recession, there are a couple tricky aspects when it comes to calculating after repair value.
Values Going Down
When values are heading south, it makes the ARV process a little more difficult—but not impossible. Keep an eye on the trends in your market and adjust accordingly. The upside is that you probably got a better deal on the property and when you’re finished with the rehab, you’ll be in a better position to sell or rent.
Buyers and renters will acquire a nicely finished home much more quickly, and you’ll be able to sell for more money than almost everything else on the market.
Days on Market Going Up
During recessions, demand for certain properties can drop, meaning more time on the market and downward pressure on prices. As long as you’re aware of this and have multiple exit strategies, you’ll be able to plan accordingly.
How do you calculate ARV? What tips/advice can you offer other investors? What missteps have you made?