If you’re trying to decide whether to make renovations or move into a new home to get what you need out of your living space, there are many considerations to take into account, including whether you need more space, how you like the neighborhood, and for parents, the quality of local schools. All of these factors also apply if you’re trying to decide whether to buy a fixer-upper or something more move-in ready.
Should you want to look at this from a purely dollars and cents perspective, one useful calculation is 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 acronym stands for repair, this is really about calculating the value of any renovation. After all, most people aren’t putting holes in the walls.
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 they can expect to get out of renovations.
Additionally, if a mortgage company is financing a renovation loan, they’ll rely on an appraiser’s judgement 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 to make sure they protect their bottom line later on.
How Do You Calculate ARV?
The calculation for ARV is pretty simple:
Property's Current Value + Value of Renovations/Repairs
While the actual formula underlying this is elementary school arithmetic, there are several steps that should be taken in order to make sure the ARV calculation is as accurate as possible.
Appraise The Property’s Current Condition
Working with a local appraiser will be essential to determining an accurate valuation of the current state of the property before renovations. The appraiser evaluates every part of the home and property. That includes the following noncomprehensive list:
- 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 renovations.
Consider The Comparables
Comparables 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 had a three-bedroom ranch, they would compare it to recent sales of other three-bedroom ranches.
When we talk about your area, it’s generally meant within a mile or 2 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 yours and give you a more realistic valuation.
Estimate Value Of Repairs Or Renovations
If you’re getting a renovation mortgage, your lender is going to require that you have a renovation plan. This gives the appraiser a basis to look at those renovations and determine how much value they would add to your home based on the comps in your area that have those 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. Because your home is collateral for a loan, your lender can give 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 these renovations. As an example, just because it costs $23,000 to do a bathroom renovation doesn’t mean that you’re going to get $23,000 back in value when you refinance or sell the house. It’s important to remember that some renovation projects add more value 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 be spending to acquire a home they’re looking to renovate. The rule works as follows:
ARV x 0.7 = Purchase Target
Let’s run through a quick example to show how this works. If you’re looking at a house and you estimate that the value after renovations would be $400,000, you should spend no more than $280,000 on the home.
The reasoning behind this target is that investors know that no renovation ever goes absolutely as planned. It’s reasonable to expect some cost overruns. This rule helps anticipate those things and prevents blowing the budget.
Things To Consider About ARV
ARV is a useful tool, but it’s not perfect. If you plan to use it to determine whether a renovation is worth it, go for it. Just 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, things become cliché by being true nearly all the time. When it comes to real estate, the value of your home is definitely impacted by what’s going on just down the street. Demand for ranches is negatively impacted if those who want to buy in your neighborhood decide they want colonials.
Although national home value numbers often get the headlines, local markets are the key most of the time. That’s not to say national events never have an impact on the market. With COVID-19 pushing us all inside our homes for an extended period, many have come to realize that their current living space doesn’t work for them and want to renovate or find a new home.
One of the effects of this desire for a new space is the fact that both new and existing home prices have gone up because of COVID-19. There’s just a lot more demand and we’re definitely in a seller’s market.
Value Changes During Renovation Process
When you get a renovation loan, one thing that’s important to realize is that the value may change in the middle of the renovation process. The reasoning for this is that renovations 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 cost may also change, typically being higher in the event of changes. Especially if they don’t have access to the original blueprints, an architect and contractor may not know what’s on the other side of a wall until they start doing the demo. If they run into an unexpected issue, this can delay your project, add costs or both.
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 do as much for the value of your home as you might believe.
In cases where there is a mismatch between what homeowners or investors value in a home and what the appraiser is seeing based on the market data, you could end up with a lower than anticipated ARV.
There’s not really anything you can do about it, but you just need to be aware of the fact 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.
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 there are often cost overruns by the nature of renovation.
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 for any given feature. If there’s a gap between what you value and what other buyers typically like to see, you could have a lower valuation.
While Rocket Mortgage® doesn’t offer renovation loans at this time, we do have a guide on the home-flipping process that you might find useful. Moreover, there are other types of loans like a cash-out refinance that can be used to fund your dream project.
If you’re interested in taking cash out of your existing home based on your current property value, you can apply online.