What is After-Repair Value?
The After-Repair Value (ARV) of a commercial rental property is the market value of the property upon completing repairs, renovations, and related improvements.
How to Calculate After-Repair Value (ARV)
The after-repair value, or “ARV”, is the fair value of a property once repairs, renovations, or property improvements have been implemented.
Commercial real estate (CRE) investors that engage in the strategic acquisitions of properties – formally referred to as the value-add strategy – will seldom lease out rental units immediately post-closing of a transaction.
Under the value-add strategy, the real estate investor acquires a property with the objective of raising the rental rate of an existing property.
There are exceptions, of course, but for most value-add acquisitions, the investor will first spend time to improve the quality of the individual property units, amenities, and common areas post-acquisition.
In short, the more rental income generated by the property at stabilization relative to the income level prior to the ownership transfer, the higher the return on the property investment.
If the impact on the pricing rate increases while the occupancy rate remains stable (or improves), then the after-repair value (ARV) of the property increases – all else being equal.
The period of unoccupancy, assuming the vacant units are not available for rent (i.e. “off the market”) can be perceived as an investment in itself, as the property improvements will pay off over the long term.
The new property owner, however, cannot merely step in and increase the rental pricing, to state the obvious. Instead, tangible improvements must first be applied to the property to improve the pricing rate and total rental income collected, or else the renewal rate and the occupancy rate would reduce.
If the rental units of the property are priced above the market rate for no valid reason, existing tenants are less likely to renew their current leases and new tenants will instead sign elsewhere.
Therefore, the property owner must truly add real value to the property for the increase in pricing to be justifiable and thus resulting in a higher property valuation (i.e. sale price).
After-Repair Value Formula
The formula to calculate the after-repair value (ARV) of a property is the purchase price of the property plus the value anticipated from repairs, renovations, and related improvements .
The property purchase price is the asking price set by the seller, at which the property can be acquired as of the present date.
The value of renovations, on the other hand, is the sum of all repair, renovation, and related spending activities.
Note: While the cost of renovation is a cash outflow, the value of the spending is input as a positive figure here, rather than a negative integer.
How Do Existing Tenants Impact the After-Repair Value?
If there are existing tenants at the acquired rental property, the new owner must first strictly abide by the tenants’ leasing agreements with prior management until the lease terms come to an end.
The rental payments from the occupied units can offset some of the foregone rental income, contributing a stable stream of income for the property owner while changes are made elsewhere.
Note that the presence of existing tenants only applies to value-add projects, not developmental projects, where the investor purchases land on which to construct a new property.
In contrast, there are no existing tenants for developmental projects, considering the building is built from scratch.
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If the average repair value (ARV) of a property exceeds the purchase cost, repair costs, renovation costs, and holding costs, then the rehabilitation project might make sense.
If it does not, then an investor may need to bid lower on the property or find a more suitable property to rehabilitate.
Generally speaking, the 70% rule is often applied to analyze the ARV in the residential real estate market.
Based on the 70% rule, a real estate investor can estimate the maximum purchase price of a property (i.e. set the “ceiling” on pricing).
The 70% rule is most often used among house flippers, who fix and flip homes in a short time frame.
Simply put, the 70% rule states that an investor should refrain from offering more than 70% of the ARV of a potential property investment, after adjusting for repair costs.
After-Repair Value Calculator
We’ll now move to a modeling exercise, which you can access by filling out the form below.
After-Repair Value Calculation Example (ARV)
Suppose we’re tasked with calculating the after-repair value (ARV) of a commercial property acquired at the end of 2023 as part of a strategic acquisition.
The property acquired, a commercial office building, was purchased for $2 million.
- Purchase Price = $2 million
The pro forma data regarding the anticipated repair and renovation costs are as follows.
- Repair Costs = $240k
- Renovation Costs = $100k
- Holding Costs = $60k
- Other Fees = $20k
Given those cost estimates, the total renovation cost comes out to $520k.
- Total Renovation Cost = $240k + $200k + $60k + $20k = $520k
Combined, the after-repair value is $2.52 million.
- After-Repair Value (ARV) = $2 million + $520k = $2.52 million
In conclusion, we’ll confirm the purchase price meets the 70% rule by dividing the after-repair value (ARV) by 70%. The maximum allowable offer (MAO) for the rental property is therefore $3.6 million, which is the most that the investor should bid for the property investment to be economically feasible.
- Maximum Allowable Offer (MAO) = ($2.52 million × 70%) – $520k = $3.08 million
