What Is the 70% Rule in House Flipping?

The 70% rule in real estate can be helpful when comparing properties and making a final determination on which one is the best investment. Understanding the ins and outs of this rule is imperative to using it to your advantage.

What Is the 70% Rule?

The 70% rule is a formula commonly used by real estate investors as a barometer when purchasing distressed properties for a profit. The formula calculates the maximum amount to pay for a given property once two key factors—the after-repair value (ARV) and estimated repair costs (ERC)—are considered.

The 70% Rule Further Explained

The 70% rule states that real estate investors shouldn't pay more than 70% of the ARV minus the repairs needed. For example, if a house is $150,000 and needs $20,000 in repairs, the 70% rule states that no more than $85,000 should be paid. The math looks like this:

• $150,000 (ARV) x .70 (ARV percentage) = $105,000
• $105,000 – $20,000 (ERC) = $85,000 (buying price)

This formula is commonly used by house-flipping investors to decide how much to pay on a fix and flip.

70% Rule: Formula and Example

The formula itself is rather simple: Once the ARV and ERC are calculated, you then plug in the numbers.

Take a house that has an ARV of $100,000 and needs $20,000 in rehab. The last variable to figure out is what discount to buy at. In this case, we'll use the traditional 70% rule, so 0.7 is plugged in.

• Formula: (ARV * 0.7) – rehab
• Example: ($100,000 * 0.7) = $50,000

Why Is This “Rule” Critical?

This "rule" is critical because the ARV and rehab costs are used in conjunction to calculate the formula. If either of these numbers is inaccurate, there's the potential to operate on less-than-desirable margins. If the wrong price is calculated, profit margins can quickly diminish or be wiped out completely.

ARV and rehab should always be fixed numbers based on the investment exit strategy. However, the ARV percentage amount minus repairs should be variable. Furthermore, this rule may be disregarded as investors become more creative.

For instance, if investors intend to buy and make a long-term hold play, betting on appreciation, they may be able to afford to pay more. In this situation, investors may be able to buy at 101% ARV if the financing is favorable and the area is desirable.

Application of the 70% Rule

With this in mind, let’s examine the application of the 70% rule.

Housing inventory price point

The 70% rule can be adjusted, depending on the price point of the housing inventory. For instance, if lower-end housing is purchased in Texas with an ARV of $70,000 to $90,000, you may be able to negotiate a deeper discount—say, 65%.

The best way to get in tune with the local market is to review what recent cash sales have been in the same community as the subject property. For rehab properties, it will show what margins everyone else is operating on. If wholesaling is the exit strategy, this will show how much of a discount is needed to buy.

Major market area

All real estate is local, but major market areas influence the formula. The formula will need to be adjusted based on the market it is in.

In California, the 70% figure could go as high as 80% or 85%. In Dallas/Fort Worth, Texas, where housing is more affordable, 70% to 78% should serve well.

Even more important are the hyperlocal factors based on the subject property itself. The ARV percentage will fluctuate from ZIP code to ZIP code, subdivision to subdivision, even within the same major market area.

Exit strategy

This rule varies depending on the exit strategy. For example, landlords can usually afford to pay more than house flippers because flippers incur higher costs for renovations and must cover agent fees and related expenses.

On the other hand, landlords can pay more, as their strategy focuses on short-term cash flow and long-term value appreciation. For instance, landlords in northern Texas often purchase properties for their rentals at 76% to 80% of the ARV.

Other models

Other investors may prefer a different formula, such as calculating offers based on what they want to earn on the project.

For example, if an investor wants to rehab a house and net at least $18,000 after accounting for factors such as holding costs, closing costs, and real estate agent commissions, other models are a viable alternative to the 70% “rule.”

Is the 70% Rule a Good Guideline?

The 70% rule can be a good indicator—but not the only tool—used to make a decision on a fix and flip. As with any type of investment, investors should list the estimated costs to calculate their potential profit.

Costs to consider on fix-and-flips

• Repairs (always be conservative)
• Carrying costs (interest, points)
• Monthly costs (utilities, HOAs, insurance, taxes)
• Buying costs (back taxes, cash for keys, liens, code violations)
• Selling costs (commissions, closing costs, transfer fees, title insurance)
• Unexpected costs (add $5,000 to be safe)
  

These are the basic costs investors should consider. From there, take the ARV, subtract these costs, and subtract the minimum profit ($20,000). This is what the purchase price should be.

When Can Properties Be Bought for More Than 70%?

The No. 1 reason a property can be bought for more than the 70% rule is when a real estate agent is also the investor. As agents, they receive a commission of 2.5% to 3% on the purchase and save an additional 3% when selling, as they can list the property themselves. Although this 5.5% to 6% is taxable, it still enables them to offer above the 70% guideline.

Experience also plays a key role. Seasoned investors have a deep understanding of the market. Their ability to accurately estimate the after-repair value (ARV) and confidence in their pricing allows them to exceed the 70% rule by 1% to 2%.

Finally, experienced investors often have advantageous financing arrangements with banks. They might not be able to finance the entire purchase amount like other investors using hard money or private money, but they have been doing it long enough to build up a bankroll that can pay for down payments and repairs.

Final Thoughts

The 70% rule is more of a guideline, not a hard-and-fast rule. The percentage of ARV minus repairs will vary based on local markets, exit strategy, and housing type. All these details should be taken into consideration when calculating an offer.

Investors who stay in tune with the local marketplace and apply the 70% formula as a guideline instead of a blanket rule will make their offers more competitive and their investments more lucrative.

This post originally appeared on the BiggerPockets blog.