What is the 70% Rule in house flipping? Is a question that many new and up and coming real estate investors often ask.
The “70% Rule” gives new real estate investors a basic and simple guideline for making offers on a new property purchase that they intend to fix and flip.
The first step in making a healthy profit on your house flip is to buy the property at the right price; the 70% rule can help you to do that. Yes, the purchase price is the single most important factor that determines the eventual success of your project.
Exactly what is the 70% Rule in House Flipping?
The 70% Rule of real estate investing means that you should aim to pay no more than 70% of what is known as the after repair value (ARV) of the property, 70% of the predicted or estimated value of a property after all repairs are completed, minus the repair costs.
To give an simple example, if a property’s ARV is $200,000, and it needs $50,000 in repairs, then the 70% Rule states that the most an investor should pay for it is $90,000.
That is, $200,000 times 70% = $140,000, minus $50,000 = $90,000.
We should hastily point out here that to call the ‘70% rule’ a rule is actually very misleading because in the real world it is rare that deals work out exactly that way.
It is, in fact, no more than a useful guideline that is designed to encourage you to make sure that you leave room for your profit and the inevitable, unexpected, additional expenses that often arise.
Limitations of the 70% Rule
The 70% rule can be a useful guideline for sure but, in reality, it only works if your initial, key numerical estimates end up being accurate.
In the real world of real estate investing you could underestimate the rehab costs. This often happens to fix and flippers, even the experienced ones.
You must also really know the ARV of properties in the area.
If you get either of these vital estimates wrong, and it is possible to get them wrong by a large margin, then your deal may not end up being profitable and you may even lose money.
To avoid any nasty surprises you can always ask a few realtors their professional opinion about the estimated after repair value of a house that you are contemplating flipping.
Give these realtors all the standard information about the property and also the details about the rehab that you are doing.
Those numbers provided by the experienced realtors will hopefully give you an additional and perhaps more accurate range finder on your appropriate property sale price point.
How to Be Flexible
You should adjust the 70% rule depending on the price point of the housing inventory.
In other words, your purchase price all depends on the housing supply; if the housing supply is higher than usual and the demand is lower, you may be able to buy your property at a deeper discount than the 70% rule would suggest.
One of the very best ways to come up to speed with the situation in your intended market is to look at the recent cash sales in the same locality and subdivision as your property.
If you are flipping you will get a good indication as to the margins that others in the area are operating on.
As you likely already know, every real estate market is completely different depending on the city and location, and major market areas heavily influence and affect this formula.
In a market like California for instance, you will need to adjust the 70% to a significantly higher percentage.
Even within the same major market, depending on the desirability of the location, there will be major fluctuations in this formula.
Exit Strategy
The 70% rule will also change depending on the exit strategy.
If you are competing against landlords, typically they will be prepared to pay more than someone like you because as a rehabber you will have higher repair costs in order to add the desired value. You also must factor in realtor commissions and other expenses.
Summary of what is the 70% Rule in House Flipping?
The basic analysis that needs to be done for your house flip is how much will you buy the property for and how much will you sell the property for.
Unfortunately, as simple as that sounds, the number crunching required is not as straightforward as you might think.
That is because all the numbers are only theoretical until the final completion of the project.
The only numbers that are certain at the beginning of the project are the purchase price and the costs associated with the closing.
You will make the most educated estimate that you can in regard to how much the rehab will cost, but as we stated earlier there are, more often than not, unexpected expenses with rehab projects.
It is not only about the materials but also about the length of time that the project will take. Taxes, utilities, insurance, loan repayments will all need to be paid for the duration of the project.
Then, when it comes to the selling price, even with your best efforts to get a realistic ARV, sometimes even very similar homes in the same neighborhood sell for very different amounts.
Seasonality is also a factor to take into consideration and certain months are tougher to sell homes in than others.
Please also keep in mind that late spring and early summer months are the best times for the seller and house prices are usually at their lowest in the winter months.
So, by all means, use the 70% rule, but only as a flexible (very flexible) guideline.
In addition to that rule, you also need to control your expenses, do your research, and complete the rehab efficiently and quickly.
Do this and your project will work out well, not only on your calculator but also in real life.