What is the 70% rule in house flipping?
The 70% rule is a staple real estate calculation, investors have on hand to be able to quickly calculate how much they should be paying for an investment property. It is also known as the 70-30 rule. Think of the 70% rule as a barometer or rule of thumb. The 70% rule states that a property investor should be aiming to pay no more than 70% of the resale, or after repair value (ARV) of their target property, minus any necessary repairs, known as estimated repair costs (ERC). The after repair value known as the ARV is the value of the property after it has been rehabilitated for sale.
Real estate investment can be an uncertain venture, but with diligence, focus and sound planning the financial rewards are highly desirable. If you desire to invest in property but are adverse to the responsibilities of a landlord, property flipping may provide accessible opportunities for tangible real estate investment returns. Property flipping when executed well is a effective way of generating substantial income. You may also have come across this practice under guise of fix and flip, buy to sell or simply, trading.
For seasoned real estate investors who purchase, renovate and sell-on properties for profit there is need to be able to know the numbers involved and make sound financial assumptions when investment opportunities (which are often at short notice) arise. Handy calculations offer a great way of testing and retesting your model for a particular property project and assess viability of your plans.
What is the 70% rule calculation?
This quick and ready tool draws from the calculations used in securing high-stakes and expensive bridging finance where a lender or financial institution may offer up to 70% of the purchase price of an asset. In this case the 70% rule can assist you in assessing whether a potential fix and flip property is truly worth it. Many seasoned property investors are using this rule without knowing its name but practical experience affords the need to be able to determine which investments are affordable and profitable. As a novice investor it is important you get your initial purchase right as this will determine the profit you walk away with at the end of your project.The 70% rule helps to create figure that is realistic for your market and leaves room for ROI.
A sample 70% rule real estate calculation.
A property with an ARV of $200,000 can be evaluated for purchase price using the 70% rule as follows:
The ARV = $200,000
The cost of repairs = $22,000
With the 70% rule the price you should pay is 0.70 x $200,000 (ARV) = $140,000 – $22,000 (the cost of repairs) = $118,000
$118,000 is the proposed purchase price of the house. To get a $200,000 property for $118,000 seems a great deal, but it is important to keep track of the costs and expenses involved in your house flipping project which will have to be paid out of your gross profit,It is by no means a hard and fast financial evaluation; you may find yourself paying more or less than this calculated value for your property investment. With the 70% rule, the price you aim to pay assures that you can walk away from your deal with some kind of profit.
The 70% rule in action – how will it work for me?
If you have a budget of $100,000, what is achievable? Well, depending on the cost of repairs, for example, $20,000, using the 70% rule you would be able to achieve an ARV of:
$100,000 + $20,000 = $120,000
$120,000 is 70% of 171,428 meaning that this is likely to be the ceiling of ARV you would be able to achieve at an initial house price of $100K.
70% is the typical percentage used but where the value of a property exceeds $200K it may be well worth tightening your numbers witha 75% rule calculation as used by seasoned investors. With the 70% your focus is entirely the cost of repairing and renovating the property as the major deductible. It is important to remember that the 70% rule over looks soft costs such as:
- financing
- insurance
- legal fees
- realtor fees
- permits and inspections
- unexpected mishaps
- property and local taxes
These soft costs can eat up as much as 15% of your property’s initial cost. It is important to be conservative and as detailed and accurate as possible about the costs involved in your house flipping project to secure your profit,
So, is the 70% rule a reliable calculation?
Establishing your plans for a house flipping project, in particular the arrangement of finances, needs care and attention to detail. It is important to have as thorough a breakdown as possible of your genuine costs for property refurbishment. Think of the 70% rule as a ball-park figure or estimate and then take steps to drill down on a more accurate financial assessment of your plans. Repair costs can make or break even the most sound-seeming investments and if you are purchasing foreclosed or auctioned houses, you may encounter dilapidation or other property problems that add to your bills. Your price-point for your property investment is also a big factor in how the 70% rule will work for you. Picking up foreclosed or distressed property in a rough or run-down area may seem like a bargain, but can expose you to risks such as thefts and vandalism which will erode your margins.
Cautions for using the 70% rule.
Also avoid using this guideline literally and make allowance for real estate opportunities where you are not rigidly sticking to the parameters of this rule. Make allowance for some flexibility in getting your offers accepted or achieving your ideal price. Know the limits of the 70/30 rule which may not work for exit strategies or rental investments. The 30% will always have to bear the brunt of your costs so do not make financial decisions on your gross figures. And remember that any lenders will only be providing finance for the original price of the property.
Another disadvantage of the 70% rule is that it can never fully replace the diligence of studying the property market in which you wish to invest. Take the time to study house prices demographics news rental rates and any other information that can provide insight into how successfully you can perform your flip. In addition you want to keep your ERCs realistic with sound advice and quotation from construction professionals who are able to give as accurate an assessment as possible of the repair and renovation work necessary and its cost. what prices are well renovated properties in your target area selling for?
The 30% will always have to bear the brunt of your costs so do not make financial decisions on your gross figures. And remember that any lenders will only be providing finance for the original price of the property.
