Every industry has its acronyms. People active in a given industry are familiar with them. Everyone else, not so much. A good example is ARV. People with experience in real estate investing know what this means. How about you? Do you know what ARV is and why property investors care about it so much?
ARV stands for ‘after repair value’. It is the expected value of a property once necessary repairs are made. It is important to real estate investors because it affects everything from acquisition to funding to potential resale. An investor who doesn’t understand the ARV principle could easily find him or herself in trouble after buying properties that need extensive repairs.
How ARV Is Determined
The good news about ARV is that it is not hard to figure out. It’s not even determined by the current condition of the property in question. ARV is determined by comparing the current value of similar properties in the area. Determining ARV is a lot like a bank appraisal initiated by a mortgage application.
To figure out ARV, an appraiser looks at the value of similar properties that don’t need repair. Let’s say an appraiser finds five similar houses that recently sold at prices ranging from $100,000-$200,000. Simple math returns an average sale price of $150,000. That is the ARV of the property in question.
Funding Real Estate Investments
ARV is important to funding because it influences the amount of money an investor is able to borrow. According to Actium Partners, a hard money lender based in Salt Lake City, lenders will typically look at ARV before funding a distressed property. They need to know that the rehabbed property will have enough value to cover the loan in the event of foreclosure.
ARV can also influence the amount being borrowed in relation to the lender’s normal LTV. The lower the LTV, the higher the investor’s down payment in relation to ARV. In turn, this influences how much the investor should spend to acquire the property in question.
Following the 70% Rule
A common way to determine how much an investor should pay is to employ the 70% rule. This rule establishes the maximum acquisition costs of a given property by calculating 70% of ARV and then subtracting the estimated cost of repairs. Just to clarify, total acquisition costs include both the purchase price and any other associated costs – like attorney’s fees, title fees, etc.
Moderately distressed properties tend to be easier to manage with the 70% rule. When you are talking seriously distressed properties requiring major renovations to structural elements, it is a lot more difficult to get in under the 70% threshold.
ARV Is an Estimate
Tying all of this together is the reality that ARV is just an estimate. Lenders and investors alike need to keep that in mind when making decisions. As volatile at the real estate market can be from one season to the next, today’s ARV can be somewhat inflated compared to real sale prices six months from now.
This dictates that ARV be considered in light of current market trends. If the market is trending downward, ARV may have to be estimated a bit lower. Likewise, there may be room for a higher ARV if the market is trending upward.
All of this is important to real estate investors because it determines how they acquire, repair, and then sell or rent properties. ARV is a critical element to lenders as well. As such, it is something that cannot be ignored by investors. Ignoring ARV is a good way to put oneself in a losing position.