Can you break the 70% rule?

Question

6 months into real estate investment I have used this criteria to determine if the deal was worth doing.  Now that our marketing is working better and the deals we have been looking at recently have ARVs in the $400-$600k, I am finding it hard sometimes fit into this box.

One deal we are looking at has an ARV of $450k, Renovation budget of $117k, and we are stuck at a purchase price of $230k with the seller.

($450,000 X .7) - $117 = $205K using 70% rule.  Our lender will lend the 70% and we are out of pocket $25k for the difference.

Once all the dust settles we have a potential of $72k @ $230k purchase price.  The location is in a desirable area of Houston and the DOM of homes in the neighborhood, at this price point are less than 60 days.

So is it safe to venture out of the “70% rule”?

What is the threshold you like to see?

When do you feel it is safe?

Other details that may matter: Home was built in the 1956, 2100 SF, extensive updating/rehab and we are adding 350SF.

Thanks again for the direction.

J Scott · Answer

In my opinion, rules of thumb -- like the "70% rule" -- shouldn't be used to make purchasing decisions.  To be a successful rehabber, you must know your exact costs and you're desired profit targets to know if a deal is a good one or not.

Saying that 30% of the resale value is enough (or more than enough) to cover your fixed costs and profits is meaningless if every investor has a different amount of fixed costs and different profit targets.  For example, if you're buying cash, your fixed costs will be lower and therefore more of that 30% will be profit.  If you're getting a HML, more of your 30% will go to fixed costs and your profit will be lower.

You need to know exactly how much you'll spend on fixed costs (purchase costs, loan costs, holding costs, selling costs) and exactly how much minimum profit you'll accept and then plug the numbers into The Flip Formula to determine how much you can pay:

Max Purchase = ARV - Fixed Costs - Rehab Costs - Profit

If you plug the numbers of this deal into that formula, how much does it tell you that you can pay for the property?  Don't go higher than that number.

Here is an article I posted on the BP Blog a couple years ago on this topic:

http://www.biggerpockets.com/renewsblog/2010/03/10/determining-maximum-purchase-price-mpp/

Will Barnard · Answer

If you have read up on the 70% rule, then likely you should have seen some of my comments which state that the rule needs to be adjusted according to circumstances and one of the circumstances is exit values (ARV). In the exit value range you are speaking of, 75% results in a very reasonable return assuming your numbers are spot on. This even allows for borrowed funds costs.

As J mentioned, I would do this deal all day long!
Now, if you were at 75% and the exit was $125k, then I would save you are very tight, especially with using borrowed funds. If this was a 75% deal and the exit was $1.2M, again I would say your spread is too tight and does not allow enough room for downside.

Sam Craven · Answer

J  Scott i read that article when i was searching the forum for answers before i posted this and i like your approach.  We have a solid understanding of our actual costs and have nice spreadsheet that makes calculating necessary expenses for different approaches quick.

I guess its just up to us to determine if $325k of someone eleses money and $25k of our own is worth a potential profit of $72k...Sounds like the consensus is that it may be.

thanks again!

Will Barnard · Answer

When you say returns, are you refering to ROI or the all in % rules? If ROI, I shoot for 20%+ on any and all deals while never going below 15% . If the rule, your higher end may differ from my higher end or any others higher end. At $650k, you are pushing the limits in my opinion by going at 75%, I would want to be in the lower 70's. as stated before, when exit values extend into the million plus, your max should be 70%.

Sam Craven · Answer

I was hoping you would chime in Will Barnard, this is one of 2 high end deals we are negotiating at the moment.  The other is 4500sf and has an ARV of $600-$650k and is surrounded by million dollar homes.

With properties in the higher ARV ranges what returns do you like to see?
At

Chris Weiler · Answer

To me the 70% rule of thumb is not just about leaving enough room for a 30% profit. Plenty of people would be happy with a guaranteed return of half that. To me the minimum of 30% is about leaving enough room for unexpected costs and a potential lower sales price. Anything less and you are increasing your risk as well as your potential profit.

John Bowen · Answer

Is it a project that will eat up a ton of your time and keep you up late or a deal that can run well with limited input?
I find that to be a big deciding factor on some of our projects. If it takes up to much of my time from my day job where I earn the cash for these projects I have to pass. I expect to earn 20% minimum on anything we do.
Of course we are more buy, rehab, and hold people along with using our own cash and doing a refi afterwards too.

J Scott · Answer

Personally, I think a $72K profit on a $450K ARV and only $25K of your own investment is a no-brainer.  But, again, that's just based on my profit and ROI targets...

Congrats on the deal!

Bryan Hancock · Answer

The "rule" of thumb strikes again!

Sam Craven · Answer

Our contractor is vetted and i am confident in the ARV.  My gut says go for it but i wanted some more experienced rehabbers to back up my gut.  Thanks Jim.

Can you break the 70% rule?

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