Investing in real estate often means purchasing properties that need some fixing up. Unless you have a constant cash flow you can invest in the homes, chances are you need to borrow the money. This is possible with both the FHA 203(K) loan and the Fannie Mae HomeStyle loan. In order to pay either loan off, though, you need to be able to sell the property for a profit. Experienced real estate investors borrow the money, fix the home up, and sell it rather quickly – this is called flipping houses. These investors pay the loan off and use the profit to purchase another home. The cycle then continues. In order to secure financing for a home in less than “good condition,” you need to know the ARV or After Repair Value. This helps you determine if the investment is worth it or if you will lose money on the deal.
What is the After Repair Value?
As the term suggests, the After Repair Value is the value of the home after you renovate it. You can consider it a sort of prediction of value. However, there is no predicting involved. You need an actual professional to help you determine the value unless you are very experienced in the real estate industry. Most real estate agents can help you come up with the right figure. Following are the steps you need to follow:
- Pull comparable sales from the area. A real estate agent can use the MLS (Multiple Listing Service) to help you find the latest sales. Ideally, you want sales that occurred within the last 3 months. If there are not enough comparable sales within the last 3 months, you can go back as far as 6 months, but proceed with caution. The homes you pull for comparison should not be more than 1 mile away and should have similar features and square footage that you anticipate the home will have after you finish repairing it.
- Evaluate the current market and coinciding trends. Have values increased or decreased in the area recently? What do the experts expect the area to do in the near future? Does changing seasons have any effect on the price of the homes? This will help determine if you can sell the home within the most profitable time.
After talking to a real estate agent, you will have a good idea of the ARV for a specific home. This is just the first step in the process.
Calculating the Costs
Next, you need to talk to the contractors. The professionals who perform the work can give you the best estimate of the pending costs. Get quotes from at least three contractors for the best results. A few questions to ask include:
- What is the cost of materials?
- What are the itemized costs of each repair?
- What is the timeline for the proposed changes?
- Do the contractors have proper licensing and insurance?
- Do they have experience with the specified renovations?
Once you look at the estimates and determine which contractors you trust the most with the work, you can determine if the purchase is worth your investment. Do not forget, you also have to figure in loan closing costs. You can expect to pay between 2 and 5 percent of the loan amount in closing costs.
In rare cases, you may be able to perform some of the work yourself. Do not forget, though, that time is money. If you have to invest too much time in the project, it may not be worth it.
Putting the Pieces Together
Now you have to put the pieces together. You know how much the home may be worth after the renovations. You also know how much it will cost you to make those changes. Your lender should be able to give you an estimate of the loan closing costs as well. Adding the purchase price, renovation costs, and loan closing costs together, you can determine the full cost of purchasing an investment home.
The next step is to determine if you can sell the home for a profit. If you researched the trends in the area, you know the best and worst times to sell in that area. Will the contractors be done with the work in time to meet that window of opportunity? If not, will you have to sit on the investment until the right season comes up?
If you have a buyer lined up or you plan to keep the home yourself, you have some leeway. However, if you purchase homes which need renovation to flip them, you have to have a plan in place. Timing and budget are everything.
Not All Renovations are Worth It
Keep in mind that not every renovation you make will have an effect on the home’s value. A real estate professional can help shed light on which renovations make the largest difference in your area. In general, the following changes affect values the most:
- Any exterior changes often reap a great return – Things like a new garage door, new siding, or a new roof almost always pay off
- New flooring – Especially wood flooring provides a great return on your investment
- Energy efficient changes – Anything that improves the energy efficiency of a home, such as attic insulation can enhance the value of a home
- Kitchen face lifts – You don’t have to make major changes in the kitchen; sometimes just painting it, upgrading the faucet and appliances is enough to increase the value of a home
Do not bother making any luxurious changes to a home – you will probably not see a return on that investment. Buyers want to see a home that is energy efficient, functional, and has great curb appeal. Your money is best spent in these areas. Anywhere else and you could lose out on your investment.
Understanding the After Repair Value will help you make the best choices for your investment or even your own home. Anytime you pay for real estate, you create an investment. Chances are you want to see a return on that investment whether right away by flipping the home or down the road when you sell your owner occupied property.