By Hard Money Russ
ARV stands for after repair value.
When looking at a property that is ripe to be flipped, how do you determine if it will be profitable or not?
To calculate the potential profits of a fix and flip, you need to know the estimated purchase price, repair costs and after repair value of the property.
It is the initial value of the property plus the value gained after repairs.
In other words, ARV is the estimated sale price of the home after renovations are completed.
Just like with any other product or service, there are many factors and variables to think about when it comes to projecting ARV.
For ARV, a basic but powerful approach is to research comparable properties using online real estate listing sites such as Realtor, Trulia or Zillow.
Find comparable currently listed and recently sold properties in your target neighborhood.
These are the most important factors to consider in your comparison analysis:
For more information you can read Neighborhood Analysis for The Home Buyer, The Top 6 Factors.
Consider Frank, a fix and flipper was looking to purchase a 3 bedroom, 4 bathroom home in Los Angeles, California.
After touring the subject property Frank's contractor finds the kitchen, flooring, plumbing and roofing all need repairs.
These renovation costs, combined with the holding costs, will add up to $50,000 dollars (assuming the property takes 6 months to complete).
Because of the poor condition the home has a listing price of $195,000 dollars.
Frank is trying to determine the maximum amount to pay for the house in order to make a healthy profit.
When it comes to projecting repair costs, the best practice is to obtain multiple estimates from contractors to avoid being overcharged.
The holding costs include property taxes, insurance, utilities, maintenance and HOA fees.
Using the real estate websites listed above, Frank discovers 5 comparable homes sold within the last 90 days, all in excellent condition and within a 2 mile radius of his subject property.
The sales prices of the respective properties are as follows: $250K, $280K, $300K, $320K and $350K.
The average sale price of these 5 properties was $300,000 dollars.
Although not precise, Frank uses this price as an estimated ARV for his subject property.
In order to determine his initial offer on the subject property, Frank uses the 70% rule.
The 70% Rule
The 70% rule states a fix and flip investor should pay no more than 70% of the ARV minus the renovation costs.
This provides you with the maximum purchase price in order to have a 30% profit margin after renovations.
The formula works like this:
70% ARV - estimated repair costs = initial purchase price
This 30% margin will give you a sizable buffer to still be profitable in case unexpected costs arise or the market turns south, forcing you to decrease the listing price.
Frank calculates the following:
Therefore, $160,000 dollars is the maximum purchase price he should pay for the subject property, in order to satisfy the 70% rule.
Without any mistakes, Frank stands to make $90,000 dollars of profit on this fix and flip.
The $90,000 dollars also protects against any unforeseen expenditures.
For example, if the house needed a new $15,000 dollar roof as instead of the projected $5,000 dollar repair cost, Frank would still net a healthy profit of $80,000 dollars.
Calculating ARV is a tool every fix and flip investor needs to be familiar with.
The 70% rule is a good starting point, but not a magical number.
You may find yourself adjusting this percentage based on competitiveness and other market conditions.
With increased familiarity of comparables in your local market you will be able to quickly identify the most profitable fix and flip deals using ARV calculations.
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