Violating the 70% rule and still making money?

[Wendell De Guzman]

Have you violated the 70% rule and still made money?

For those of you who don't know, the 70% rule is basically the multiplier you have for the ARV (or After Repair Value) from which you deduct the repairs and it will give you the MAO or Maximum Allowable Offer for a house you're going to acquire. The formula allows you to be sure you'll make money on a fix-n-flip. Let's illustrate with actual numbers on a deal I am working with.

The house is worth $265K and it needs $20K in repairs. Using the 70% rule, my MAO is: 0.7 x $265K - $20K = $165.5K

For details about this house, see this: http://www.biggerpockets.com/forums/223/topics/121707-real-life-of-a-real-estate-investor?page=2#p804253
Actually, I gave the seller a price of $170K not $165.5K just to see his reaction.

The gurus taught the 70% rule as "gospel"... but have you ever wondered how that rule is derived in the first place? Based on my experience rehabbing houses, I believe the 70% rule came out because it included a 20% profit margin for the rehabber as well as roughly 10% selling + holding costs. The total is 30% - so deducted from 100%, equals 70%.

SO let's say I re-sell the house above for $265K...

I will spend 6% in real estate agent commissions, about 1% in closing costs and about 3% in holding costs (say I re-sell the house in 6 months, I have to pay the taxes, insurance, utilities plus marketing during those 6 months). My net of sale to me is:
$265K less $265K x 10% = $238,500

Once I deduct the $20,000 in repairs and my acquisition price of $165,500, I get: $238,500 - $20,000 - $165,500 = $53,000 profit
$53,000 is 20% of $265K

If making $53,000 profit sounds "TOO much" for you... think again. You're investing $165,500 (acquisition) + $20,000 in repairs or $185,500. Making $53,000 gross profit means a 28.6% ROI. This is an acceptable return considering you're making a sizable investment.

Now, here's how I would make money even if I violated the 70% rule...

I propose to the seller that I can pay him $190K but it has to come in 2 payments: $20K cash now and the balance in 6 months or when we sell the house. Here's the math on it:

Re-sell price $265K less 10% costs = $238,500 net of sale to me
After deducting $190K (the now higher acquisition price) and the $20K repair costs, my profit went down to $18,500. However, I only invested $20K downpayment + $20K in repairs plus 3% in holding costs (or $7,950) for a total of $47,950. My ROI is 38.6% - which becomes better because I am not risking as much money as before.

Of course you have to get the seller to agree to a 2-pay purchase (so this set up will not work for bank owned properties). But the above technique can be used to set yourself apart from other investors making low-ball offers based on the 70% rule. Also, you get to do more properties (if you're using your cash) because you only invest a third or less of what you need vs. an all-cash offer.

Have you violated the 70% rule and still made money on fix-n-flips? If so, how did you do it?