If you’re considering owning or investing in residential real estate, there’s a term you need to add to your real estate: “adjusted value” (often referred to as “ARV”). Simply put, ARV is the updated value after repairs or improvements are made, taking into account the original purchase price and the cost of refurbishing.

Often, ARV is discussed in terms of house flipping, but it is also important to understand for individual home hunters and property investors. Here, we’ll explain the basics of ARV in real estate, including what it is, how it’s calculated, and who should use it.

What is ARV?

When someone decides to flip a house, they first buy the property and then invest in renovations to increase its market value. The ARV is simply the new, improved value of that property – after you’ve made the improvements, repairs, and improvements the seller wants.

Why is ARV important? That’s because savvy flippers want to invest in assets they know will yield a profit — and ARV can help them make that decision.

“The ARV takes into account the final value of the renovated property and acts as a way to determine how much money should be reasonable to invest,” said Martin Carrion, owner of Soco Wine Country Properties, a Santa-based real estate agency. Rosa, California

In short, ARV is a useful tool to help flippers and other real estate investors decide whether buying and renovating a home is worth it and based on its profitability. If you’re looking to buy a home to live in, it can also be helpful – especially if you’re in the market for a fixer-upper.

How to calculate ARV

If you want to calculate the ARV on a particular house, use the following method to get a rough estimate. If you want a more accurate figure, be sure to work with an appraiser.

1. Look at comparable properties

Your first step is to find five (or more) comparable properties that have recently sold in the area where the home is located – also known as a compass. You can find these listings on real estate sites like Realtor.com or your local MLS, or work with a real estate agent to see if they see homes that match what you’re looking for.

With comps, it’s great to find homes that match yours in location, age, size, condition, and style. Ideally, these homes have sold within the last several months or even the last year.

The more specific these factors are, the better you can calculate the correct ARV.

2. Determine the price per square foot

Next, divide the selling price of each condo by the home’s total square footage to determine the price per square foot. For example, if a comparable property with 2,500 square feet sold for $500,000, the price would be $200 per square foot. Run this calculation on each of the comps, then average them all.

3. Plug the numbers into the ARV equation

Once you’ve gathered this information, you can plug it into the following formula.

Average price per square foot (in all comps) of the property X square footage = ARV

Let’s go through an example. Say we have our eye on a 2,000 square foot fixer-upper. Let’s assume that five condos—recently sold, similarly sized homes in the ‘code—have an average price of $150 per square foot. We multiply $150 by 2,000 to find that the ARV on our target home is $300,000.

ARV and 70 percent of the rule

While simply knowing a home’s ARV is important, it’s even more powerful when used in conjunction with the 70 percent rule, a general real estate guideline designed to help renters determine the maximum amount they should spend on a home. Profit.

Specifically, the 70 percent rule states that a slip property should only be purchased if its value is 70 percent or less of the ARV (excluding renovation costs). The formula to calculate this is as follows:

(ARV X 0.7) – Estimated Replacement Value = Maximum Discount Value

Continuing with the last example, let’s say our ARV is $300,000, and we expect to spend about $50,000 on repairs and improvements. To get the maximum discount rate, we first calculate 70 percent of $300,000—that’s $210,000—and deduct $50,000 in maintenance costs. So our maximum discount should be $160,000.

Who uses ARVs?

ARV is incredibly useful for realtors and real estate investors. For them, the main goal is to buy a house at a low price, spend money on renovations and put it back on the market at a very high price. In most cases, they have no desire to live there themselves.

“Fix-and-flippers use ARV to understand the project’s viability,” says Denis Shirshikov, strategist at Awning.com, a real estate brokerage for investors. “Traditional investors view this as ‘baked equity’ as maintenance costs increase the property’s value beyond the mortgage.”

Mortgage lenders rely on the ARV for real estate to assess how much money they are willing to lend to flashers, investors and homeowners for their renovation projects. Basically, the more valuable a home is after repairs, the more money buyers can borrow for home improvement loans.

Last word on ARV

ARV is a tool for flippers and real estate investors to understand two main things: whether or not a house is worth flipping and, if so, how much the property is likely to sell for after renovation. House hunting can also help individuals realize whether the fixer-upper they’re looking at is a good deal at the current price and how viable the remodeling financing is.

That being said, it’s important to remember that ARV is not an official price or a guaranteed figure. Rather, it is an estimate based on a series of learned assumptions. The actual value of a home will vary depending on the comps used to calculate the ARV, the local real estate market and actual renovation costs – to name a few. And of course, some variables can change during the transaction process. Still, ARV can be a starting point for answering that all-important question: Is a particular property a good buy — or a money pit?