… and naturally, you want a piece of the pie.
Good! It’s never too late to profit from real estate (people will always need somewhere to live, after all).
But there’s a problem…
…a giant prison-cell, mindset-hurdle, confusion-creating kind of problem.
How in the heck do you know how much a home is worth? You don’t have any experience in the real estate world, so how are you going to know how much you should purchase a piece of real estate for? How do you know you’re actually going to be able to make a profit?
How do other real estate investors know?
Well, it’s really just some simple math.
Here’s how to do it.
How to Find After Repair Value (ARV) of a House
Imagine that you found a piece of distressed real estate you’re interested in purchasing and flipping (as either a wholesaler or a house flipper). Assuming that the seller is as motivated as you need them to be and that they’re interested in selling their home to you, it’s time to see whether that deal is going to be profitable for you.
The first thing you need to do is find the After Repair Value of the home.
What does that mean?
It’s exactly what it sounds like: Basically, how much will the home be worth once it’s repaired to normal market expectations.
Note: If you’re wanting to fix and flip homes, that’s an important nuance. You must understand the market and what kind of home quality the market’s buyers expect. This will save you from over-repairing the home and lessening what could be a hefty profit.
If you’re going to fix and flip homes, then ARV is important for obvious reasons. It’ll tell you how much you can expect to sell the home for once you’re done repairing it – which, in turn, reveals how much you should buy it for and how much you can spend on repairs.
If you’re a wholesaler, ARV is important for the same reason above and for one more additional reason: namely, that investors you’re flipping the home to will usually want to know the ARV of the home you’re trying to sell them – most will want to see all the comps you’ve run on the property.
How to Calculate ARV:
ARV = (Property’s Purchase Price) + (Value of Renovations)
Now that you understand why After Repair Value is so important, how do you determine the ARV of a home?
Ask a Real Estate Agent to Run Comps
The easiest way to determine the ARV of a property is to ask a real estate agent friend of yours to run comps for you. Work to build a healthy relationship with the agent and many will do it for free. Some will require a small fee.
Whatever the case, when an agent run comps, they’ll send you a report showing homes similar to the one that you’re considering buying (similar in size, location, lot size, and the number of beds/baths) that have sold recently, are trying to be sold, or are pending sale.
The report will have the details of the home (bed, bath, square footage, year built) and the price per square foot that the home is being sold for or did sell for (see “Orig Price” vs. “List Price” vs. “Sale Price”).
Here are the comps I received recently from my real estate agent buddy.
Once you have this report in hand, you now just need to find the most similar homes to the one you’re considering buying, average their price per square foot, apply that number to the home you’re considering buying, and make slight adjustments for discrepancies. Here are a few things to keep in mind.
- If a home sold for very high or very low relative to the other similar homes you’ve compiled, then don’t consider it in your calculations. Outliers like that will only throw off your ARV.
- Try to find homes that have the same number of bedrooms and bathrooms.
- Try to find homes within the same exact neighborhood with the same type of positioning (not next to a busy street, downslope, no neighboring houses are in distress, etc)
- If you have to increase the radius on the comps for lack of nearby similar properties, do so sparingly, and seek expert help from an agent or appraiser if needed.
In the end, you should have a healthy idea of what the house can be sold for once it’s repaired to market expectations.
Need a Real Estate Website?
How to Do it Yourself
If you’d rather run comps yourself rather than asking a real estate agent to help you out, then the most user-friendly place to do that is Zillow. Not for their Zestimates, though. In fact, I’d pay very little attention to their Zestimates if I were you – many experts question their accuracy.
The best way to use Zillow to run comps is by typing in the address that you’re considering buying into the search bar and change the filter to “Recently Sold.”
Click the search icon. All of the yellow dots on the screen indicate homes that have recently sold. Click on one or all of them and Zillow will tell you exactly what they sold for, their square-footage, how many bed and bath they have, and lots of other details.
Now all you have to do is find the homes which are most similar to the one you’re considering buying, put them onto a spreadsheet with the price they sold for, their price per square foot (Price Sold/Square-footage = Price Per Square Foot), their number of bedrooms and bathrooms, and any other pertinent details you’d like to include.
Average out the most similar home selling price tags with the bulleted list from the “Ask a Real Estate Agent to Run Comps” section of this article in mind and you’ll have your ARV.
How to Find Your Max Bidding Price
Now you have the ARV of the home you’re considering buying.
For the sake of simplicity, let’s assume that you set the ARV of the home at $200,000 after running comps. The first thing to consider is what real estate investors lovingly refer to as the “70% rule.” Basically, it means that house fix-and-flippers try to pay about 70% of the ARV of a home minus the repairs needed. This gives them a healthy 30% profit and makes sure they can afford any unexpected repairs and still make a profit.
What Investor Will Pay for Home = (ARV x .7) – Cost of Repairs
Assuming that the cost of repairs for the home is $20,000, here’s what that formula looks like using our $200,000 ARV example.
$120,000 = ($200,000 x .7) – $20,000
In this case, the 70% rule says the investor should pay about $120,000 for the home to make a 30% profit (about $60,000).
Not every fix-and-flipper follows this guideline, but it’s a good rule of thumb to pay attention to. If you’re fixing and flipping homes, then you’ll want to consider the 70% rule when purchasing a distressed property.
If you’re wholesaling homes, then you need to take the math one step further.
Since you’re getting a cut out of the middle for finding the deal in the first place and the investor you’re flipping the home to will likely follow something similar to the 70% rule, then you need to factor in a cut of cash for yourself.
The formula will look more like this.
What Investor Will Pay for Home = ((ARV x .7) – Cost of Repairs) – Wholesaler’s Fee
If you wanted to make $10,000 in the middle, then here is how the math works out, for instance.
$110,000 = (($200,000 x .7) – $20,000) – $10,000
This means that the house fixer and flipper should expect to pay about $110,000 for our example-home after you (the wholesaler) take out your fee.
Generally speaking, these numbers will be important to share with your buyer (if you’re a wholesaler) so that everyone is on the same page and understands where money is going and why you’re pricing the house at what it’s at.
You don’t always have to share these numbers (your buyer will probably run comps of their own anyways and apply this rule). But it’s important to have on hand so you can 1) justify what you’re trying to sell the house for and 2) ensure that everyone makes a healthy profit.
You now know how to determine the after repair value of a home. This is arguably the most vital skill you as a real estate investor need. The more you practice, the better you’ll get at it. And if you have any further questions, throw em in the comments and we’ll help you however we can!