The main difference between private and traditional lending is that private lenders base their loans on the after-repair value of the property. In contrast, conventional lenders base it on the current market value. Both the after-repair value and the current market value is ultimately determined by a licensed appraiser. However, the after-repair value is the value that is not there at the time of the appraisal. It’s simply a projection of what the property might be worth once the planned renovations are completed. It’s based on the sale prices of similar properties rehabbed to the same extend our investor plans to rehab hers.
Private money lenders take a significant risk basing their loans on the after-repair value. After all, there are no guarantees for rehab to be ever completed. This is what makes private lending risky and why conventional lenders stay away from it. The main benefit to the borrower is obvious though: to offer the maximum leverage to buy and renovate real estate. In layman terms, the higher is the spread between your purchases price and your after-repair value, the less of your own money you need to invest.
The ability to estimate the ARV correctly is a critical skill for every investor. To understand your deal’s profitability, you need three key numbers: your purchase price, your rehab budget, and your ARV. The relationship between them will determine whether you will make or lose money. Ultimately, it would drive the decision on the maximum price you are willing to offer and whether you walk away from the transaction or jump in with both feet.
So what is the best way to determine the after-repair value of a home?
Do not delegate your after-repair value evaluation.
The first rule of determining the ARV is not to delegate it to anyone. You are the only person benefiting from the transaction’s success or bearing the repercussions of the failure. It is not the time or place to cut corners. Of course, the best way to determine the ARV is to have access to the Multiple Listing Systems. Unfortunately, access to it is limited to real estate agents and licensed appraisers. Thankfully, there are plenty of other platforms that are free and available to consumers. Here is the list of the latest and the best.
When estimating the ARV, it pays to get into the weeds.
Get comfortable using those free tools and learn to make adjustments to their estimates. In other words, do not base your decisions on the Zillow number alone. Make sure the comps you are using are of (1) comparable style; (2) similar size; (3) the same vintage. A common mistake among new-ish borrowers is to ignore the fact that one property has a basement while another does not. Learn to think like a real estate appraiser: adjust the value of the subject property based on its unique pluses and minuses as compared to the comps.
Don’t succumb to wishful thinking.
One of the most common mistakes that I see in my private lending career is concentrating on the highest-priced properties while ignoring the lower-priced comps. For example, if there are two lower-priced homes .2 miles from the subject property, you cannot base your value on the price of a home that is a mile away. Remember, you will be competing against those homes. Why would someone buy a property that is priced higher if they have a choice of lower-priced homes (all other attributes being equal)? You simply cannot ignore the truth – even if doesn’t fit into your narrative.
We are fortunate to live in an area that continues to post record appreciation rates. But, as we know well, past performance is not a guarantee of future results. Do not account for appreciation while calculating your future after-repair value. Have many of our borrowers benefited from the real estate appreciation in the DC area? The answer is an absolute and resounding “Yes!” However, the name of the game is to buy below the market value and NOT to hope that the rising tide will lift all boats, your including.
Get the expert opinion
Taking the lead on calculating the ARV of your potential flip doesn’t mean you have to go at it alone. If you are working with a real estate agent, ask him or her what they think. Better yet, find a private lender who could confirm your estimate before you spend money on the appraisal. As the DC-area top hard money lenders, we work hand-in-hand with our borrowers to make sure that their flip is a success. After all, the more money you make, the more secure our private loans are and the more repeat business we have. While we don’t want to be your personal assistant in running your comps (this is your job as an investor), we can certainly offer another set of eyes to confirm your estimate.