The Most Important Number In Real Estate Investing
Real estate investing is a numbers game and there can be a lot of numbers…You can quickly find yourself looking at the 70% rule, 1% rule, repair costs, purchase prices, holding costs, and about a hundred other numbers for every deal. All these numbers are good but especially when you are starting out, you really need to focus, and of all the numbers you could focus on, I believe one is most important…That number is the after repaired value or ARV.
The ARV can lead you to success or failure yet so many people either do not focus on it, don’t know how to calculate it, or fudge their numbers and try to use a bad ARV. These are all bad ideas! Let’s take a look at how to calculate your after repaired value and three ways that I use ARVs every day in my business.
How To Calculate The After Repaired Value (ARV)
To calculate the ARV, you need to look at what other similar properties have sold for in the area. Note: I said sold for…not what they are currently listed at. The listing price is just what someone wants for the property and can be way more than what a property is worth. The sold prices are what someone was actually willing to pay for the property. You want to find 3-4 similar sold properties that you can use to find the market value of your property after you have fixed it up.
Let’s say our potential investment property is a 3 bedroom 1 bathroom property built in 1950 and is 1000 sq ft. So, we need to look for properties as close as we can find to this one. That means the same number of bedrooms, same number of bathrooms, built around the same time, similar square footage, and in the same area.
Comparable Property #1: 3 Bedroom 1 Bathroom 950 sq ft – Sold for $124,450 or $131/ft
Comparable Property #2: 3 Bedroom 1 Bathroom 1050 sq ft – Sold for $135,450 or $129/ft
Comparable Property #3: 3 Bedroom 1 Bathroom 975 sq ft – Sold for $126,750 or $130/ft
Based on what comparable properties have sold for in the area, we know that the average sold price per foot is $130. Since our property is 1,000 sq ft we multiply 1,000 * $130 = $130,000. The ARV of this property is $130,000.
Watch out for these traps: Using properties that are a lot bigger or a lot smaller than your subject property. You need similar sized properties so that your price/ft will transfer accurately
Using properties from outside the neighborhood. Many times, property values differ greatly from one neighborhood to the next. Just because they are near your property, does not always mean that they are comparable
Thinking that you are going to fix your property up so nice that it will sell for way more. Neighborhoods top out in value, so even if you put in golden doorknobs and marble tile you are not likely to get much more than the top value in that neighborhood.
Now that we know how to calculate an accurate ARV, let’s see how we can use it.
The Sales Price
The ARV is your potential sales price after you have completed all the necessary repairs. If you plan to repair this property and then resell it for a profit, you need to know what your sales price will be before you start your project. There is no sense in buying a property, spending a bunch of time and money fixing it, only to find out that when you sell it, you are not going to make any money.
By having an accurate ARV, you can also determine how much you can spend on repairs and still make your desired profit. If you know that you can purchase the property for $70K and you know that you can sell the property for $130K, and you want to make a $25K profit, then you can spend up to $35K on repairs and still make that profit.
ARV = $130K – $70K (purchase price) – $25K(profit) = $35K for repairs and still making your desired profit.
Your Offer Price
You can also use the ARV to calculate your maximum allowable offer. Let’s say that the seller wants $50K for their house…is that a good deal? Maybe and maybe not. Let’s say that the house needs $25K in repairs…is that a good deal? Maybe and maybe not. It is all going to depend on what the property will be worth in the end or the ARV.
If you calculated the ARV to be $130K and you know it needs $25K in repairs, then $50K sounds like a pretty good deal. But, if you looked at the comps in the neighborhood and determined that the ARV is $75K, then this does not sound like a good deal at all. Its sounds like you are going to be doing a whole lot of work for nothing.
If you think a potential property might be a good deal, then start by calculating the ARV and work backwards. We will use the same property as before with an ARV of $130K. Next we will calculate our repair estimate (or if you are not comfortable with repairs, you can find some contractors to help your out) and that total is $35K. You have decided that for this project you have a desired profit of $25K. Now just work backwards to get to your maximum allowable offer.
ARV = $130K – $35K(repairs) – $25(profit) = $70K is your maximum allowable offer
Anything below $70K as your purchase price and you are looking good…anything above that number and you are going to start to squeeze out your profit.
How Much You Can Borrow
The ARV is also going to determine how much you are able to borrow against the property. If you don’t have cash to purchase and repair the property or if once you repair the property you would like to refinance and pull some of your cash back out, then you are going to need to borrow against the property. How much you are able to borrow against the property is going to be based on the ARV.
Scenario 1: If you are planning to borrow the funds required to purchase and rehab the property, then you are going to need an investment property loan. Almost all investment property lenders are going to base the amount they are willing to lend you based on the ARV of the property. Many investment property lenders are willing to loan up to 70% of the ARV (percentages will vary between lenders). So, before they will agree to the loan, they will calculate the ARV of the property and determine the maximum loan amount based on that ARV.
ARV = $130K * 70% = 91K is the maximum loan amount
If you can purchase and repair the property for less than $91K then you can potentially borrow all of the funds needed for the deal. If it is going to cost you over $91K, then you will need to come out of pocket for the rest.
Scenario 2: You plan to keep this property as rental and after you have completed all the repairs you would like to refinance the property and pull your cash back out. You still need to start with an accurate ARV because the lender that is doing the refinance is going to do an appraisal after the property is repaired and they will allow you to refinance up to a certain percentage of the new appraised value.
If you did a good job calculating your ARV before you started, that number should be very close to the new appraisal value that the lender calculates. In this case, let’s say that your lender will allow you to refinance up to 75% of the appraised value and that appraised value came in at $130K.
Appraised Value = $130K * 75% = $97,500 is the maximum loan amount
In this situation, if you can keep all of your costs under $97,500, then you could refinance back out all of your costs, leaving you with $0 left in the property.
You could spend all day looking at numbers and you could find hundreds of opinions on what rules you need to follow. Most of these all have their place with certain properties or situations, but you can not spend all your time trying to make each investment fit all of the rules. It is my opinion, that if you could only get really good at getting one number correct, that it should be the ARV.
If you start with an ARV that is much too low, then you will have trouble ever finding a deal that will work, and if you predict a fantasy ARV that is way too high, you are likely to get hurt in the end. Take the time to calculate an accurate ARV and then use it to estimate your profit, set your maximum offer, and determine how much you can borrow. Starting with an accurate ARV will start you on the path to success.