After-Repair Value (ARV): Meaning And Use
Buying a new house comes with a lot of considerations, including the neighborhood, amount of living space and even the local school districts. All of these factors also apply if you’re trying to decide whether to buy a fixer-upper or something more move-in ready. There are a lot of decisions to make if you’re buying a home for your family and considering making some repairs or alterations, and especially if you’re hoping to flip the house for a profit.
From a purely dollars and cents perspective, one useful calculation to consider if you’re buying a home that needs some work is the after-repair value (ARV). This article will go over what ARV is, how it works, a general rule used by investors and a few considerations to be aware of.
What Is After-Repair Value (ARV)?
After-repair value, or ARV, is the value of your home after renovations are completed. Although the “R” in the abbreviation stands for repair, any renovation should be included along with repairs in your calculations.
Whether you’re buying a new home that could use some TLC or renovating your current one, an ARV is used to determine the value of the property after renovations. This is useful for home buyers and homeowners alike to get an idea of how much financial benefit they can expect to gain from renovations.
Additionally, if a mortgage company is financing a renovation loan, they’ll rely on an appraiser’s judgment of what the value should be after renovations are completed. This makes getting an accurate value crucial. Rocket Mortgage® doesn’t finance renovation loans at this time.
Finally, if you’re looking to flip real estate, the final number for an ARV can make all the difference in terms of whether a project can be completed profitably. We’ll go over one rule used by real estate investors and house flippers to make sure they protect their bottom line.
How To Calculate ARV In Real Estate
The formula for calculating ARV is pretty simple:
ARV = Property's Current Value + Value of Renovations and Repairs
While the actual ARV formula is simple, there are several steps that should be taken to make sure your calculations are as accurate as possible.
Step 1: Appraise The Current Value Of The Property
Working with a local home appraiser will be essential to determining an accurate valuation of the current state of the house before renovations. The appraiser evaluates every part of the home and property, including but not limited to the following:
- Size of the home (measured in square footage)
- Amount of land/lot size
- Number of bedrooms and bathrooms
- Curb appeal
- Special features (pool, finished basement, attached or detached garage, etc.)
- Overall condition
Not only will this give you a better idea of where you stand before any work is done, but lenders will likely require it depending on how you’re financing your repairs or renovation costs.
In addition to valuation, it’s important to know that savvy investors often put a cap on the amount they’re willing to spend to purchase a property. This accounts for the fact that sometimes a renovation may be too expensive to take on.
Step 2: Consider Comparable Properties
Comparable properties are key in making the appraisal process objective. A comparable property (comp) is defined as a recent sale of a property that’s similar to your own home within your area. For example, if you have a three-bedroom ranch, you’d compare it to recent sales of other three-bedroom ranches.
When discussing your area, you’ll generally consider properties within a mile or two of your residence. There can be exceptions if you live in a rural area with fewer residents.
If you’re not at a stage where you’re ready to get an appraisal and want to self-calculate an ARV, another way to get access to comps would be to work with a real estate agent. They have access to the multiple listing service (MLS), a repository of all available properties in your area.
Real estate agents can use the data to run a comparative market analysis of homes with similar properties to give you a more realistic valuation.
Step 3: Estimate Value Of Repairs Or Renovations
If you’re applying for a renovation mortgage, your lender is going to require that you have a renovation plan. This gives the appraiser a basis to look at your plans and determine how much value they would add to your home based on the comps in your area with similar features.
The other reason your renovation value is important is that your maximum loan amount is tied to the value of your home after the repairs. Since this type of loan is considered a secured loan your house acts as collateral and your lender may loan you more than the property will end up being worth.
On that note, it’s crucial to be realistic about the value you’re going to gain from renovating. For example, spending $23,000 on a bathroom renovation doesn’t guarantee an added $23,000 in value when you refinance or sell the house. It’s important to remember that some renovation projects increase home value more than others.
How Do Real Estate Investors Use The 70% Rule?
The 70% rule is a guideline that some real estate investors use to determine the maximum amount they should spend to acquire a home they want to renovate. The formula for the 70% rule is:
ARV ✕ 0.7 = Target purchase price
Let’s run through a quick example to show how this works. If you’re looking at a house and the estimated value after renovations would be $400,000, you shouldn’t spend more than $280,000 on the home.
The reasoning behind this target is that investors know that no renovation ever goes exactly as planned. It’s reasonable to expect some cost overruns. This rule helps anticipate unexpected spending and is a good rule of thumb to consider so you can increase your potential profits.
Considerations To Make About ARV
The ARV is a useful tool, but it’s not perfect. If you’re using the ARV to determine whether a renovation is worth it, be sure to keep the following points in the back of your mind.
Real Estate Market Changes
Real estate being about location is said so often that it’s considered cliché. However, this is one instance where the cliché is accurate. When it comes to real estate, the value of a property is impacted by what’s going on just down the street. For example, if colonial houses are selling well in your neighborhood, but ranches aren't, the value of a ranch home will be lower.
Although national home value numbers often get the headlines, local markets are key. That’s not to say national events never have an impact on the market. The COVID-19 pandemic meant home offices were more crucial and popular than ever, even driving buyers to renovate to add square footage or purchase larger homes. With the current financial market instability, it’s hard to say exactly how the housing market will be impacted and if a buyer’s market or seller’s market is on the horizon.
Value Changes During Renovation Process
When you get a renovation loan, it’s important to realize that the ARV may change in the middle of the renovation process. Especially if the renovation can take a long time. The market today may look a lot different from the market 6 months or a year from now.
Beyond the value of the renovation itself, your renovation cost may also change. Typically, in the event of changes, your costs will increase. Unexpected problems can pop up during the renovation process, especially if your architect or contractor doesn’t have access to the original blueprints for the house.
It’s common to run into unexpected problems during demolition if you don’t know what’s waiting on the other side of a wall. If you run into unexpected issues they can delay your project, adding costs and time.
The Appraiser’s Opinion
Your favorite feature of your renovation plan may be your spa bathtub, but if that’s not a feature that a lot of people are demanding, it may not increase the value of your home.
In cases where there is a mismatch between what homeowners or investors value in a home and what the appraiser estimates based on the market data, you could end up with a lower than anticipated ARV.
Anticipating market trends is extremely difficult, so you’ll need to be aware that an appraisal is going to be a cold, hard look at market facts.
The Bottom Line
After-repair value is designed to take into account the current value of your property plus the value of any repairs or renovations planned in the process of getting a renovation loan to purchase or refinance your home. These are most commonly used in home flipping, but they could be used by any homeowner to make improvements to their existing space.
While the ARV is an important tool, things outside the renovation itself can affect the property value, including market conditions, both before and during the renovation process, as well as the actual market demand. If there’s a gap between what you value and what buyers are typically looking for, you could also have a lower valuation.
Are you ready to get started on a home renovation? A cash-out refinance or home equity loan can fund your project. Take the first step and start the application process today.
Apply for a mortgage today!