How does a hard money lender determine the ARV of my fix & flip?

Estimated reading time: 6 minutes.

Post outline

1. What is the ARV?
2. Why is the ARV important?
3. How do hard money lenders use appraisals?
4. What are the key considerations in a fix & flip appraisal?
5. Additional hard money lender underwriting
6. Conclusion

What is the ARV?

ARV stands for “after-repair value” and indicates how much a property is worth after it has been fixed up.

To use a simple example, let’s say that you purchase a property for 100k, and you spend 50k fixing it up. Ideally, the ARV would then greatly exceed the amount of money you spent purchasing and rehabbing the property. An example of an outstanding ARV in this case might be 250k, however oftentimes the difference between the cost and the ARV is not quite that great.

Why is the ARV important?

The ARV is important to you (the borrower) on a fix & flip because it gives you an indication of how profitable your project is going to be.

If you purchase an investment property for 100k, fix it up for 50k, and then are only able to sell it for 175k, that doesn’t represent a great return on your investment, or a return on your time.

The ARV is also important to you because it often determines how much leverage, or how big your loan size can be.

One of the most important metrics that hard money lenders use when deciding whether or not to make a fix & flip loan is LTV, or loan-to-value. LTV, even though it is oftentimes referred to as one value, can actually represent a range of values, although that is beyond the scope of this post. For most fix & flip lenders and borrowers, when they refer to LTV, they are really referring to LTARV, or loan-to-after-repair-value.

LTARV is important to a lender because it is a reliable measure of risk; the higher the LTARV, the riskier the loan, all else being equal. Likewise, the lower the LTARV, the less risk the lender is taking on.

The ARV is also particularly important in a fix & flip scenario because the exit from the hard money financing is a sale of the investment property. Unlike a refinance, where the hard money lender wants to ensure that the borrower is able to obtain a new loan, in a sale, the hard money lender wants to be sure that the property will sell.

How do hard money lenders use appraisals?

In order to determine the ARV of a fix and flip, a hard money lender will generally use an appraisal. The appraisal is a document generated by an appraiser that provides an estimate of the value (often as-is and after-repair) of the subject property. The appraiser provides this estimate through looking at “comps”, or comparable properties. These comparable properties are generally similar to the subject property in a few key areas, and thus provide a good indication of the value of the subject property.

Many hard money lenders use appraisal management companies, or companies that specialize in working with lenders to coordinate and provide appraisals. However, some hard money lenders work with independent appraisers, particularly if these appraisers have good knowledge of a specific geography or location.

An appraisal for a fix & flip will generally show both the as-is and after-repair value for the subject property. The as-is value of the property can show you if you’re overpaying, and the after-repair value, as discussed, estimates the value of the property after you renovate it in accordance with your scope of work. 

Hard money lenders’ reliance on outside appraisals varies quite widely; some hard money lenders put a lot of weight on the appraisal, and others don’t even order appraisals! Oftentimes, lenders that don’t order appraisals lend in a very specific geography and have a great idea of what properties are worth within that footprint, so the appraisal becomes redundant.

What are the key considerations in a fix & flip appraisal?

For the purposes of this post, we’ll assume that the appraisal is of a 1-4 unit residential property. For a 1-4 unit residential property, the appraiser is going to be looking at a number of variables, but the following three are some of the most important;

1. Similarity of property type to the subject property
2. Similarity of property size/features to the subject property
3. Proximity to the subject property

Appraisers will generally look for properties that have sold recently (say within the last 6 months) that are similar in property type, size/features, and are located near the subject property.

Let’s say that you are looking at fixing and flipping a 3 bed, 1 bath SFR (single family residence) in a western suburb of Chicago.

The appraiser likely is not looking at duplexes, because the property type is dissimilar.

The appraiser likely is not looking at 3 bed, 5 bath SFRs because the property features are dissimilar.

Lastly, the appraiser is likely not looking at properties that are several miles away, or in a completely different city than the subject property.

The appraiser is most likely going to be looking at 3 bed, 1 bath SFRs that have recently sold (again, say within the last 6 months) near the subject property.

Additional hard money lender underwriting

As mentioned above, hard money lenders vary quite widely in how much stock they put in an outside appraisal.

Some lenders weigh the appraised value quite heavily, and don’t do much additional underwriting at all. On the other hand, some hard money lenders don’t even order an appraisal, and instead rely completely on their internal valuation.

Odds are, the hard money lender that you work with will get an appraisal and they will also review it to ensure its accuracy. In this way, the hard money lender can be sure that the value the appraiser came up with isn’t too far removed from their internal estimate.

If your appraisal comes back with an ARV that is much lower than anticipated based on your preliminary research, you will often have the chance to offer rebuttal comps. These comps are properties that, in your view, more accurately reflect the ARV of the subject property. Lenders will sometimes (although this tends to be quite rare) alter their determination of the ARV based on rebuttal comps.

Conclusion

In sum, the ARV, or after-repair value, indicates the value of your investment property after your have renovated it.

The ARV is important because it gives you and the lender an idea of not only the potential value of the investment property, but also your ultimate profitability on the project.

ARVs can be determined by an appraisal, or an internal underwrite by the hard money lender. Hard money lenders vary quite widely in their reliance on appraisals, but most hard money lenders do use appraisals to substantiate the estimated ARV.

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