Veteran real estate investors are true visionaries. When they look at a distressed property, they don’t see the broken windows, knee-high grass, and years of neglect. Instead, they see a thriving rental property, a beautiful fix and flip in an up-and-coming neighborhood, or a nice paycheck.
But how do they see so much potential where everyone else sees a run-down house? It’s simple; they know how to calculate the after-repair value.
How to calculate after repair value
Whether you’re a wholesaler, fix and flipper, or buy and hold investor, the after-repair value (ARV) of a home is crucial to your investing strategy. The ARV is the amount an investor can sell a home for once it’s been renovated and repaired. It’s usually a price range and is influenced by a few factors, including:
- The location of the property
- The year the property was built
- Previous significant damage like a fire or a flood
Investors calculate ARV by finding comps, which are similar properties in a 1-5 mile radius that have recently sold, and calculate the average price per square foot. Then they multiply this number by the square footage of the property they are interested in to estimate its value.
The ARV formula looks like this:
Average Price Per Square Foot of Comps x Square Footage of the Deal
How do you find comps for real estate?
There are several ways for investors to find comparable properties. In the past, investors drove through neighborhoods and looked for houses with similar attributes to their desired deal. However, finding accurate information on sales price and property specifics required access to real estate agents or a real estate license and access to the multiple listing service (MLS).
Now, finding comping data is much easier, because there are numerous resources that aggregate property information. Many investors use property intelligence software like BatchLeads, which use built-in comping tools to make calculating property value easy. These tools give investors access to comps, detailed property insights, sales prices, and the estimated value of the property they’re considering. This takes the manual work out of calculating ARV so investors can work faster without worrying about mathematical mistakes.
How do you use ARV to know if you should invest in a property?
When investors are trying to determine whether or not to buy a property, they use the 70 percent rule. This rule states that:
An investor’s final offer on an investment property should never exceed 70% of its ARV.
This rule helps investors maximize their return on investment (ROI) and avoid losing money if one or more of the following situations occurs:
- There are unexpected renovation costs
- They have to hold the house for longer than expected before reselling
- There’s an economic downturn that causes housing prices to fall unexpectedly
Investors use the following formula to determine their maximum bidding amount:
(ARV x 70%) – Estimated Repair Cost = Highest Offer
This rule is foundational for most investors. In fact, it’s so important that many real estate coaches won’t teach students anything until they understand it and many lending institutions will use it to limit your maximum loan amount if you’re borrowing to make the purchase.
How can you use the 70 percent rule to make smart investments?
First, you should always use the 70 percent rule when considering a deal. Never get so excited about an opportunity that you sign a contract without doing your due diligence. If you jump on a deal without doing the math first, your pockets might end up lighter as a result.
Second, remember that the 70 percent rule is still a rule of thumb, and sometimes you can afford to break it. While you should always keep it in mind, there are some scenarios where the 70 percent rule can actually cause you to miss great deals and hurt your profit.
After repair value is among the most important concepts in real estate investing. If you don’t calculate it before making a purchase, you’re putting yourself at financial risk. Not only will calculating ARV help you make a great profit on a fixer upper, it will also help you avoid overpaying if you end up in a bidding war with another investor.
Thankfully, calculating ARV is usually simple. With the combination of property intelligence and time-tested real estate wisdom, knowing how much a property is worth and what to offer on it is a simple equation.
Just remember that there are sometimes hidden factors that influence ARV and skyrocket the value of a home. Being able to quickly identify these is what sets visionary investors apart from the rest of the crowd.