The 70 percent rule is a common term used among many real estate investors when flipping houses. Don’t feel bad if you don’t know what it means, because I had never heard of it up until a few years ago and I have flipped more than 200 houses! The 70 percent rule is a way to determine what price to pay for a fix and flip to make money. The 70 percent rule can be a very helpful guide but it is not something I would write in stone and never deviate from.
What is the 70 percent rule?
The 70 percent rule states that an investor should pay 70 percent of the ARV of a property minus the repairs needed. The ARV is the after repaired value and is what a home is worth after it is fully repaired.
If a home’s ARV is $150,000 and it needs $25,000 in repairs, then the 70 percent rule states an investor should pay $80,000 for the home. $150,000 x 70% = 105,000 – $25,000 = $80,000. Buying a house for $80,000 that will be worth $150,000 may seem like an awesome deal, but you have to remember all the costs involved in a fix and flip. Here is a great article that describes the costs involved when fix and flipping.
Do I use the rule?
I rarely use the 70 percent rule when deciding on whether to flip a house or not. I like to write out all the numbers and decide on a deal after seeing my profit potential. On the above deal, I would write all my costs and see if the profit potential was worth the risk. Occasionally I will use the 70 percent rule to see how my numbers match up and sometimes I am very close to what the 70 percent rule estimates. Other times I am not even close!
If $150,000 is the value of the home after the repairs and $25,000 in repairs are needed. I always add at least $5,000 in unknown costs to my known costs on a flip. Selling the house would cost me a 3% commission plus title insurance and other closing fees; approximately $6,500 (My selling costs are going to be lower than most people because I am a real estate agent and do not have to pay a listing agent). I will have insurance, utilities, and lawn maintenance while owning the house; I estimate those costs at $2,500. My financing costs will be about $8,000 with my financing terms and loan costs.
-8,000 = $103,000
As you can see when I subtract all my costs, I have a break-even point of $103,000. I usually want at least a $25,000 profit on my low-end fix and flips (under $125,000 purchase price). If I figure in a $25,000 profit, I should buy the property for $78,000. The 70% rule did not work out to be enough of a discount on this property and I am a real estate agent. If I was not an agent I would have more costs and the rule would have been farther off. I would need to buy the property at closer to 65% of the ARV minus the repairs to make it a good deal.
How accurate is the 70 percent rule?
As you can see, the 70 percent rule was close to what I would pay based on my own calculations. When I buy more expensive houses I usually am willing to pay more than 70 percent and when I buy cheap houses I pay less than 70 percent. I also factor in how big the repair job is going to be and how much cash I will have into a deal. For beginner investors, I think the 70 percent rule is a great way to get an idea of what to pay for a flip but I would never rely only on the rule.
Why the rule does not work well on expensive homes
It is hard for me to find flips that are bought for less than $100,000. It is hard for me to find flips to buy that are less than $200,000! When the houses get more expensive it gets much harder to find flips that meet the 70% rule. What happens if I buy a flip with an ARV of $400,000?
The 70 percent rule says I should buy the flip for $250,000 if it needs $30,000 in repairs. Not only is it really tough to find a house for $250,000 that will be worth $400,000 after $30,000 in repairs, but I may not need that good of a deal to make it a good deal for me. If I write out all of my costs I come up with this profit number:
$336,000 is my breakeven point. If I buy the property for $250,000 I will make $84,000. That would be an awesome flip but I do not need that much profit margin to make the deal work! I would be happy with a $40,000 profit. 80% of the ARV minus repairs would be a good enough deal for me at this price.
What do you need to know to use the rule?
In order to use the rule, you need to know many things. The rule is useless if you do not know the repairs, the market value, and other factors.
The ARV is the after repaired value and you must know this to use the rule. You cannot guess the value or have a huge value range. Not knowing the ARV is a great way to get yourself in trouble.
You must know what the repairs will cost as well to use the rule. The repairs always seem to cost more than you think they will and take longer than you think as well.
These are the only two things you need to know to use this rule, which is one reason I do not think it is completely accurate. The rule does not consider taxes, insurance, financing, utilities, maintenance, selling costs, or buying costs. These costs can vary greatly in different markets and on each deal. That is why I like to write out all the costs of each deal.
Can wholesalers use the rule?
Real estate wholesalers try to flip properties right away without doing any repairs. Most wholesalers are selling properties to other investors for cash. A wholesaler needs to know what another investor will pay for a home and the 70 percent rule is a guideline to know what you can wholesale a house for.
Wholesalers will need to know what investors are paying in their market for flips or rentals. The rule can be a great tool if investors are paying 70 percent for flips, but if investors are only paying 65 percent the wholesalers will need to adjust. The wholesaler will also need to leave room for their fee to be added to the deal.
Wholesalers in my market do not use the 70% rule because they know investors will pay much more.
The 70 percent rule can be a decent guideline in certain markets, but it does not work everywhere. If you are struggling to find deals that meet this rule it could because you don’t need to meet this rule in order to make a deal work. The 70 percent rule could also be way too much to pay for houses if you are in a market with cheaper real estate. I prefer not to use rules and to write out the numbers on every deal I do.