Real Estate Investing: Beyond the 70% Rule
Editor's Note: This post was originally published in January 2019 and has been completely revamped and updated for accuracy and comprehensiveness.
If you're new to real estate investing, you might be wondering how to figure out the right offer price for a property. After all, the last thing you want is to overpay and eat into your profits! But don't worry—a simple best practice called the 70% Rule can help you out.
Read on as we discuss the 70% Rule, how it works, and why it's considered a best practice in real estate investing.
What is the 70% Rule in house flipping?
So, you're curious about the 70% Rule in house flipping. Well, it's a guideline in real estate investing that helps you determine the maximum price you should pay for a property. Let's see how it works.
The 70% Rule suggests that you shouldn't pay more than 70% of the estimated after-repair value (ARV) of the property minus the cost of repairs. ARV is the estimated value of the property after it's been fixed up.
Let's say the ARV of a property is $100,000, and it needs $25,000 in repairs. To use the 70% Rule, you'd multiply the ARV by 70%, which is $70,000. Then, you'd subtract the cost of repairs ($25,000), which leaves you with $45,000. What does this mean? As an investor, you shouldn't pay more than $45,000 for the property.
The 70% Rule ensures you leave enough room for profit and miscellaneous expenses like soft costs. However, remember that it's not a hard and fast rule. It's more of a guideline to help you get a quick frame of reference to help you make an intelligent investment decision.
Uses of the 70% Rule in real estate
The 70% Rule is house flipping that can help you quickly evaluate whether a potential deal is worth your time and money. Let's look at some of its uses.
As mentioned, the 70% Rule is a simple framework focusing on the two most important numbers in any house flipping deal—the ARV and the repair costs. Using this rule, based on those two numbers, you can determine the maximum price you should pay for a property.
But the 70% Rule shouldn't be the only factor in making an offer. It's just a guideline to help you quickly evaluate prospective deals. It would be best to consider other factors like soft costs, which are miscellaneous expenses like closing costs, insurance, and holding costs.
To use the 70% Rule effectively, you must accurately forecast the ARV and repair costs. If you get those numbers right, you'll unlikely lose money on a deal. But if you're wrong, you could quickly lose tens of thousands of dollars.
So, make sure to analyze the comps in your market and talk to a real estate agent about their opinion of the ARV. The less closely the comps mirror the property in question, the less accurate your ARV estimate will be.
You can work backward to determine an offer price based on your estimated ARV and repair costs. Remember that your profits for a deal are determined by which properties you make offers on and how much you offer.
Overall, the 70% Rule in real estate is a useful tool that cuts directly to the most critical numbers in a house flipping deal. So, pay close attention to those numbers, get them right, and you'll be on your way to making a smart investment decision.
The math in a fix-and-flip deal
When it comes to house flipping, the 70% Rule can be a helpful guideline, but a more detailed analysis is necessary for a thorough evaluation of a deal. This analysis includes considering various expenses, such as financing, settlement, carrying, and repair costs, and budgeting for unexpected expenses.
For example, in a recent deal with an ARV of $200,000 and repair costs of $40,000, applying the 70% Rule would suggest a maximum offer price of $100,000 ($200,000 x 70% - $40,000). However, after factoring in other expenses like financing, settlement, carrying, and a repair cost buffer, the total expenses come to $69,000. The maximum offer price is adjusted to $101,000 to make a profit of at least $30,000.
In this case, the 70% Rule and the more detailed expenses analysis aligned closely, but this may not always be true. Ultimately, a more thorough analysis that accounts for all expenses and potential risks is necessary to make an informed decision on a fix-and-flip deal.
How accurate is the 70% rule in house flipping?
Let's recap — the 70% Rule is really just a starting point. Sometimes you may offer less than 70% of the ARV. In other cases, you might offer more. You'll most likely want to do a more detailed expense analysis to ensure you're making a smart investment.
So, what factors should you consider when determining how much to offer on a property?
Market price
First, the market price point is a big factor. If you're investing in a lower-end property market, you might run into more expenses and risks, like break-ins and vandalism. On the other hand, higher-end deals often come with fewer headaches and expenses.
Exit strategy
Your exit strategy is also important. If you're planning to rent out the property, you might not need to renovate it as extensively, and your calculations will revolve around annual yield and income rather than a one-time payout based on ARV. And if you're wholesaling deals, the numbers may look different because you're looking for a quick turnaround.
Labor and target profits
Labor and your target profits are also important factors. Some deals will require more work on your part than others, and some investors want to earn more profit per deal than others. If you find a deal that involves minimal work and a quick turnaround, you might be willing to accept a lower profit margin on the deal and pay more than the 70% Rule would suggest.
So, while the 70% Rule can be a helpful starting point for real estate investing, it's vital also to consider all of these factors.
The one reason you shouldn't ignore the 70% Rule
You might be tempted to ignore the 70% Rule altogether and buy higher than it suggests. And that's okay, as long as you take into account certain factors that we mentioned earlier, like the market price point, exit strategy, and your target profits.
But there's one reason you should think twice before breaking the 70% Rule, and that's appreciation. Let's face it: real estate values can fluctuate a lot. We saw this happen in the Great Recession of 2008 when home prices plummeted at a breathtaking speed.
So, here's the thing—you should be careful not to assume that real estate values will always go up. When running your numbers, use today's After Repair Value (ARV) and try to be conservative in your estimates.
Again, the 70% Rule can be a helpful starting point. Just remember to factor in all the costs associated with the deal, and don't forget about the unpredictability of the real estate market.
Final word
The 70% Rule is a quick and easy way to estimate the ceiling price for your real estate offers. However, conducting a detailed expense analysis before making an offer is essential. Repair costs and ARV estimates are crucial in determining your profits, so take the time to get them right by consulting multiple sources and being cautious and conservative.
Use worst-case-scenario numbers to protect your profits if you can't verify repair costs. Don't forget to include soft costs like financing in your calculations. It's better to make more money on fewer deals than to risk losing money or breaking even by taking on too many deals. By being precise and conservative in your cost estimates, you'll work less and earn more as you flip houses.
About the author
G. Brian Davis is a real estate investor who has owned dozens of investment properties over the last 15 years. He’s also the co-founder of SparkRental.com, an online resource that provides free landlord education and video series for anyone looking to build passive income from rentals.