Determining Rehab’s After-Repair Value: What NOT to DO

In real estate, you make money when you buy. That means you need to put a property under contract at a price that will allow you to make a reasonable profit after the costs of owning, renovating, and selling that property. This process can be aptly described using a quote by the former Secretary of Defense Donald Rumsfeld: “There are known knowns; things we know we know… There are known unknowns – things we do not know. But there are also unknown unknowns – the ones we don’t know, we don’t know.” I’m sure he wasn’t referring to the real estate rehab business, but you get my drift.

One of these unknowns is the after-repair value of your investment property. Not only will your future profit depend on it, but if you are working with a private lender like New Funding Resources, it will be the basis of how much the lender will lend you.

Estimating your rehab’s after-repair value can be challenging and require experience and discipline. This blog focuses on the most frequent mistakes in determining your the future after-repair value of your property. There are at least six that come to mind.

ARV Mistake #1: Overreliance on Your Real Estate Agent

As a real estate investor, you must take responsibility for the key parts of your renovation project. Determining its after-repair value is such a part. Together with the rehab costs, the projected after-repair value determines the maximum price you can afford to pay for the property. Any mistake here and you might find yourself losing money instead of making it.

For this reason, you cannot and must not delegate this research to your real estate agent. Don’t take me wrong, there are many competent agents who can offer you their valuable opinion. By all means, listen to it. Trust, but also verify: It’s your money that is on the line. Your agent, in contrast, will make their commission regardless of whether you make a profit or not. To thrive as a real estate investor, you must learn to estimate your after-repair value accurately without relying on your agent.

ARV Mistake #2: Comparing Apples to Oranges

Many factors influence the value of the property. Aside from its location, such factors are style, size, age, and condition of the home. It’s a mistake to base your after-repair value on the highest comp in the neighborhood without making adjustments for these critical differences.

For example, different architectural styles often fetch different prices. A brick colonial can sell for more than a split-level home, even if they have similar square footage and the same number of bedrooms. Please pay special attention to basements and whether your comps have them. The basement area is typically not included in the above-ground square footage. So, at first glance, the two houses are the same size, but one has a full basement, and the other doesn’t. To determine whether the property you are interested in buying has a basement:

1. Check the tax records and the MLS listing.
2. Look for any mentions of the basement, its size, and whether it’s currently finished or not.
3. Make sure the comps you are using match your subject, and if they do have a basement and your subject does not, adjust the price.

ARV Mistake #3: Not paying attention to neighborhood, legal subdivision, county, or zip code.

Real estate is all about “location, location, location.“ When choosing appropriate comps, rule number one is to stick as close to your property’s address as possible. In an urban environment, you might find plenty of comps within a quarter of a mile radius, and in the distant suburbs, you might have to expand to a mile. It would help if you also kept in mind that in some areas, properties within a small radius might be located in a different zip code or even different neighborhoods. We had an experience with a property in Prince George’s County that was located right next to the Montgomery County border. Homes are more expensive in Montgomery County, so it would have been a mistake to base that rehab’s after-repair value (ARV) on any comps located there, even if those comps were literally across the fence.

The same goes for legal subdivisions. For example, our office is located close to Kentlands, an upscale planned community with premium-priced real estate. Your subject property might not command the same price if located just outside the community.

ARV Mistake #4: Ignoring Lower Comps

One of the most common mistakes made by new investors is basing their ARV on the highest comps in the neighborhood and ignoring lower comps. Let’s assume you see three comps close to your subject property. All three are similar in style, size, and condition. One of these comps is for $250,000, another is for $240,000, and the third is for $220,000. It might be tempting to assume that your ARV is $250,000, but you will be assuming the best-case scenario. Instead, use the best practices and do what a real estate appraiser would: average these three comps. The average value would be between $235K and $240K.

ARV Mistake #5: Hoping for Real Estate Market Appreciation

Never ever rely on appreciation to boost your after-repair value. Even if your property is in a booming area, your time frame as a real estate flipper is way too short. If the market moves up, enjoy the boost to your profits. However, if the market MUST move up for you to make money on the transaction, then let’s face it: you are overpaying for it.

This is also why you cannot use current listings as comps to determine the after-repair value. Sellers can list a property for any price they like, from intentionally discounted to creating a bidding war to preposturate inflated. A comp becomes a valid comp when supply meets demand, and a seller is willing to sell at the price a buyer is willing to buy. Any unsold listing priced above the competition is just a pie in the sky.

ARV Mistake #7: Ignoring Seller’s Help

In the DC real estate market, it’s customary for buyers to ask for help with closing costs. The amount varies by sale price and geographic area but might be as high as 2% or even more. While exploring the comps for your subject, make sure that you consider the seller’s help. If it is customary to offer such help, it will be coming out of your proceeds, effectively reducing your ARV by that amount.

If you need help estimating your rehab’s after-repair value, do not hesitate to contact us. We are the premier private mortgage lender and know Maryland, Washington, DC, and Virginia inside and out. We work hand-in-hand with our borrowers to help them make money and manage their risk.