Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No.1
Real estate investors face several challenges when they first begin their property search. After finding a deal, the next step is calculating the numbers. Real estate investors are businesspeople first. Therefore, whatever deal they find, they need to understand if the property is a profitable deal. Will they make money? The answer is in the numbers and understanding what does ARV stand for in real estate is an important one. Read on to find out why.
What is After Repair Value (ARV)
What does ARV stand for in real estate is based on a few components, such as:
• Market comparables;
• Estimated renovation costs; and
• Some simple math.
ARV is important because it allows the investor to understand what they might be able to get for the sale of the property.
Know Your Comparables
To begin, the investor needs to find comparable properties that have sold in the same neighborhood or subdivision as the potential investment property. This is very important as home values can fluctuate from neighborhood to neighborhood, subdivision to subdivision.
Don’t look at what properties are selling for across town. Home prices can vary wildly across a small region. Neighborhoods right next to each other can have radical differences in their pricing. So, keep your analysis as close to the proximity of your investment property as possible.
Look for property with similar characteristics in the same neighborhood as the targeted investment property. Make sure your comparables are properties that have sold in the last 30–60 days. The housing market can fluctuate wildly in a short period of time, so something that sold 6 months ago probably is not relevant as a comparison property. Characteristics to look for include:
- Number of bedrooms
- Square footage
- Lot size
- When the home was built
Calculate Other Expenses
Some of these characteristics might not be the same, but that’s ok. They idea here is to get an educated estimate of what your investment “could” sell for after you perform the renovations. Other things to consider in your calculations include:
- Contractor estimates. Get several quotes from contractors. The last thing you want to happen is to walk into a deal and not know what you’ll be charged for the renovation. Find contractors that have good reviews and get itemized quotes if you can. This will give you better insight into what exactly the contractor intends to do and the cost.
- Material estimates. These might be included in the contractor estimates. If can be helpful, however, when comparing contractors. Also, it’s common knowledge that contractors add a little padding to their material costs. Be shrewd when it comes to materials and suppliers. These costs can be dramatically different depending on who you go through and the quality of what you buy. If you can find deals, take advantage of these. If you have a contractor that won’t work with you on your material costs, move on to the next. This is your deal so fight for your profit margins. Nobody will care more than you!
- Expenses such as property taxes, insurance, utilities, maintenance and HOA fees* can come into play when you take over the property. Renovations take time. You, as the property owner, will need to maintain these services to ensure the project stays on track.
- Appraisal fees (if needed). Not confident on your own comps analysis? An appraiser can give you an outside perspective on the value of the home in its current state. Appraisers should be from the area and understand the local real estate market.
- Inspection fees (if needed). Afraid of missing something? A professional inspector can give you a second set of eyes on potential and sometimes unseen issues with your potential new buy. Some homes, particularly older ones, can have a host of hidden issues that offer a not-so-fun surprise to your bottom line. A plumbing or electrical issue can cost thousands of dollars, and things that are not code complaint for your area might hold up the eventual sale of the property. When in doubt, bring in a home inspector to give you another opinion. You don’t want to start on a project only to discover a problem that will make you lose profits when it rears its head.
*A note on HOAs. Some neighborhoods that use HOAs can be outright tyrannical. They have rules on where you can place garbage cans, colors you can paint your house, and even the types of plants you can put in your yard. Get a copy of the HOA’s bylaws to understand what you’ll need to do (or not do) to stay within their good graces. This is one area where it is best to be prepared to avoid any headaches as you do your renovation.
The formula for calculating ARV is simple once you’ve collected your comps information. The formula is expressed like this:
Current Value of Property + Cost of Renovations = ARV
That’s it! A little math and your ready to make an offer. Of course, there are other factors to consider when putting together an offer, such as closing costs. The next step is to calculate your Max Allowable Offer (MAO) to hit your profit margins.
Drill down to understand your numbers and this will help you ensure a healthy return for your fix-and-flip property.