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Understanding what after repair value (ARV) is and how to compute for this number is essential if you're interested in investing in commercial properties, especially if you want to flip them.
In this blog, we will discuss all the basics you need to know about ARV, including how it's calculated and how to use it as a commercial real estate investor.
An ARV is essentially an estimated future value of a commercial property after repairs and improvements have been made. It is determined by referencing comparable commercial real estate located nearby. ARV is most commonly used by rehabbers who fix and flip CRE assets.
You can compute for a commercial property's after repair value by looking at comparable properties that are similar to it in terms of the following factors:
Most real estate investors try to find 4 to 6 comparable properties sold within the last three months, although sometimes, you may be forced to use comparable that were sold as far back as 6 months prior.
From here, you find the average sales price of the comparable properties to come up with the after repair value.
Let's say, for example, that you found four similar commercial properties in the same neighborhood that were rehabbed and sold in the past 3 months, and their average sale price was $1.75 million.
This is your after repair value, and you can use it to estimate the likely sales price of the subject property after you're done with the renovations and improvements.
It's possible to get a more precise after repair value by competing for the average price per square foot of the comparable properties.
Do this by dividing the total sales price by the total sq ft, then multiplying the result by the subject property's square footage.
So if you found 4 comparable properties and their average per-square-foot price is $1,450, and the size of your subject property is 1,200 sq ft, you're after repair value would be $1.74 million.
Of course, most commercial real estate investors don't want to buy a fixer-upper building at market value.
Their goal is to purchase the assets at a discount, accounting for the costs of repair. This is why wholesalers and rehabbers take 70% of ARV and deduct repair costs from it to come up with their maximum offer price.
Let’s illustrate this with an example. If a certain commercial property has an ARV of $2.5 million and its estimated repair cost is $550,000, the formula would look like this:
($2,500,000 x 70%) - $550,000 = $1,200,000
While most investors use it as the 70% standard, some wholesalers and rehabbers can go as high as 75% to 80% of the ARV.
Do note that profit margins and risks increase as the percentage used goes up.
ARV is a valuable metric for commercial real estate investors to tell if a certain asset is worthwhile or not quickly. It can also be useful in determining an offer price.
However, it's only valid if all the variables in the formula are accurate. Underestimating the costs of repair could cause you to lose a lot of money.
It's absolutely critical that you have an accurate idea of how much it will cost to repair the property if you want to use the ARV formula successfully.
Be sure to account for all expenses relating to improving in renovating the property, including:
If you're not comfortable determining a property's after repair value on your own, you can seek the guidance of a professional commercial real estate agent to get an in-depth comparative market analysis.
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