Does the 70% rule make sense on lower priced houses?

Question

Hi, I've been looking at properties in the $30-60K range.  Some of these need a lot of work.  For example, I'm looking at a house on Realtor.com in Charlotte, NC for $27,900 that probably needs the following:

New roof - $10K

new trim - $1K

new gutters - $1K

8 new windows - $3000

Wood floors refinished - $1K

Rehabbed kitchen and its floor - $6K

Just some very basic numbers, I'm looking at $22K in rehab costs, and this is on the low side, assuming that this work isn't as expensive in Charlotte AND the replacements are not high end materials.

The comps are scarce but seem to range from $45-55K, so let's call it $50.

So with the 70%, I'd offer:

70% of $50K is $35K -

$22K rehab costs-

$1000 carrying costs-

$3500 Commission fees & taxes upon sale = $8500 MAO

So this is pretty far from the initial asking price.  Is this just a bad deal?  I'm still new at this so any insight would be greatly appreciated.

Thanks!

Account Closed · Answer

Also Brian, be very careful of a house with such a low ARV. That is a price point that doesn't have a ton of retail buyers. Unless you are going to do some kind of lease option or owner financing, it may be very hard to find an end buyer unless it is an investor looking to rent the place.

Jon Holdman · Answer

The 70% rule incorporates several assumptions.  Specifically it assumes you're using hard money, that you will end up holding the place about six months, and that you sell it conventionally using an agent.  If those assumptions are true you should end up with a profit of about 13% of ARV.

In your math above you're double counting the carrying costs and the commissions and taxes on sales.  They're already in the 30% you take off the top.  That would bump your offer up to $13K.

That said, the 70% rule doesn't really account for all the fees that are fixed amounts.  Title company fees, underwriting fees, inspections and some other are often fixed amounts.  For example, appraisals seem to run about $500 whether its a $50K house or a $500K house.  Those fees reduce the profit potential for a small deal like this even if you hit the 70% number.

OTOH, it may be hard to find a HML who will do a tiny loan like this.  If you're using your own cash, then the money costs are out of the picture.

So you really need to do a detailed analysis of all of your numbers on a deal and see where you land.  The 70% rule is just a rule of thumb that's useful for an initial screening.  In this case, I think its telling you that you won't make a deal here because it says you need to buy for $13K vs. a listing price of $28K.  But if you find a deal that's closer, then do a more detailed analysis where you look at all the individual costs.  And look for possible problems.  Your profit potential here is only about $7000 even if they do sell for $13K.  Doesn't take much to go wrong before that disappears.

Account Closed · Answer

I use the 70% rule as a quick evaluation, but on sub $100k houses I do not assume any financing with that number. I usually find it difficult to meet my desired return on really cheap houses unless I buy them with cash. Here are some numbers on a rehab I am starting today:

• Purchase Price: $41k
• Cost to buy/rehab/hold: $15k
• Selling costs (commission/closing costs): ~$8k
• All in : ~$64k
• ARV $82k
• Potential profit: ~$18k

If I had to use financing, it would eat a lot of my profit. Using cash will give me a nice cash on cash return and a nice profit.

John Horner · Answer

I would not use the 70% rule on lower priced houses.  My biggest issue is that the repairs do not scale.  So as long as quality is the same, a full bath remodel is going to cost the same in a lower end house as a medium end house.  That being said, if you calculate a $30k profit on a mid range flip, and you find out you need $10k in structural repair, you still make some money. If you take a house priced half as high and get hit with that $10k repair, just a couple other things going wrong causes you to be in the red.  The structural repair is not going to cost half as much just because the house costs half as much.

Hope this makes sense!

John Hixon · Answer

Depending on the ARV and all other costs, you might need to adjust your strategy and use the 65% or 60% rule when dealing with ARV under 100K.  On higher ARV's you might be able to use a 75% rule.

This isn't coming from me.  Just yesterday I learned a lot about this subject from another pro and moderator on BP.  One of the great things about this site.

Brian Huber · Answer

Thank you for the insight, gentlemen!

Don Hines · Answer

As Jon said, I use the 70% rule on first glance to evaluate a deal. For me, it rarely is profitable for houses that ARV under $100k. I figure all the cost associated with the project, then add my desired profit. Subtract these figures from the ARV to get to an offer.

Don

Does the 70% rule make sense on lower priced houses?

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