Whether you’ve been in the real estate investment world for a while, or are new to the ins and outs of fix-and-flips, there’s a popular term you’ll likely encounter — the 70% rule.
What is the 70% rule?
Simply put, the 70% rule is a way to help house flippers determine the maximum price to pay for a fix-and-flip property in order to turn a profit. The rule states that a fix-and-flip investor should pay 70% of the After Repair Value (ARV) of a property, minus the cost of necessary repairs and improvements.
Because the 70% rule uses such a simple formula, it is a quick and easy way to determine a ballpark purchase amount—which is often needed quickly when time is of the essence in the fast-moving fix-and-flip world.
The remaining 30% is not all profit
One common mistake, though, is that new fix-and-flip investors automatically assume the “leftover” 30% will be all profit. This couldn’t be further from the truth, as that leftover 30% has to also accommodate the costs associated with purchasing, renovating and selling the property. These costs could include anything from agent commissions to closing costs, title inspections and hard money lender fees. The profit is what is left after all of the costs have been subtracted.
A tool to help prevent overpaying for an investment property
As an investor, the last thing you want to do is overpay for a property. Applying the 70% rule can help you avoid doing so, and help put you in the best position to maximize your profits.
The 70% rule calculation
To understand the basic math used to calculate the 70% rule, we’ll use an example of a $150,000 property ARV. If the property is in need of $50,000 in repairs, the 70% rule suggests that the maximum price an investor should pay would be $55,000.
Here’s the calculation:
- $150,000 (ARV) x 70% = $105,000
- $50,000 (cost of repairs) is subtracted from the $105,000 =
- $55,000 (total suggested offer price)
While the 70% rule is widely used throughout the real estate world, it is a quick guide and shouldn’t be relied upon as the final word for what you should pay for a property. The rule is helpful in giving a quick, rough estimate of what your top offer price for a fix-and-flip property should be, but you’ll also want to be sure and run a more extensive expense analysis as well.
Along those same lines, determining the ARV and rehab costs may be difficult for first-time fix-and-flip investors. Be sure to consult with an expert to make certain your offer price will actually result in the profits you’re expecting. Above all else, being conservative with both your ARV estimate and repair cost estimate will help you avoid getting into a property at the wrong cost.
If you’re just getting started in the real estate investment world, the first and most important thing you can do is create a plan. For more information on how to do so, read our blog article, “Creating a Fix-and-Flip Business Plan”.
When considering an investment property, you may not be able to access the inside of the home prior to making an offer. If that’s the case, it’s suggested that you use numbers that fall under the “worst-case scenario” in terms of your profit. This will help you avoid getting turned upside down right off the bat on your new investment, and if it turns out better than anticipated, you’ll be that much further ahead.
Adjusting the 70% rule in certain markets
Another benefit of the 70% rule is that the actual percentage used in the formula can be adapted, depending on the individual investor and the end goal. Everything depends upon the market in which you’re investing, as they differ drastically throughout the country.
- If you’re purchasing a property in a lower-end market, you may be able to change the 70% in the rule to 65%.
- On the other hand, the 70% may need to be bumped up to 80 or even 85% in a higher-end market.
To that end, it’s critical that you remain in tune with your specific market, to keep your offers competitive. To help figure out your local market, your best bet is comparing comparable, recently-sold properties around the same area in which you’re looking. If you run the numbers using the 70% rule and end up with a figure that doesn’t match what you were hoping to gain, you can adjust the percentage accordingly and move forward from there.
Should you be venturing into a market that you’ve not invested in before, you must also take into account all the additional costs that are not included in the 70% rule. These costs can include anything from closing costs to property taxes, and depending on where you’re investing, they could end up having a large impact in your final profit margin.
Read “What You Can Learn from Successful Flip-and-Fix Investors” to learn more about what seasoned professionals do to make their money go farther.
Beyond the 70% rule, there are six practices that investors recommend. Read more about them all in the article: “Six Practices that All Experienced House Flippers Follow”.
If you’re trying to determine if a prospective property would make a good fix-and-flip project, the 70% rule is definitely a tool to keep in your back pocket. However, as discussed, each market and each property has its own set of challenges and unique qualities that make it essential to seek additional guidance before making your purchase.
Ready to apply for a fix-and-flip loan from Anchor Loans? Check out this helpful article on how to get approved.
If you are seeking guidance as you prepare to go down the fix-and-flip road, we encourage you to contact the experts at Anchor Loans. We’re here to answer any and all of your questions, and we look forward to hearing from you soon.