What is the 70% Rule in House Flipping: The Ultimate Guide

The 70% rule is a popular strategy for house flippers, and for good reason. Essentially, it states that you should try to purchase an unrepaired property for no more than 70% of its after-repair value (ARV), which is the likely sale price after all necessary repairs have been completed. This may seem strict at first, but it’s designed to ensure that you have enough room in your budget to cover repairs, holding costs, and other expenses while still making a healthy profit. To break it down further, here are some key points to keep in mind when using the 70% rule:

Calculate the ARV: Before you can apply the 70% rule, you need to have a realistic estimate of what the property will sell for once it’s repaired. Look at comparable sales in the area and factor in any unique features or upgrades that your property will have.

Deduct repair costs: Once you have an ARV in mind, subtract the estimated costs of repairs, including materials and labor. This will give you a rough idea of what you can realistically afford to pay for the property.

Account for other expenses: Remember that there are additional costs associated with flipping a house, such as financing fees, holding costs (such as utilities and taxes), and real estate commissions. These can add up quickly, so be sure to factor them into your budget before making an offer.

Overall, the 70% rule is a useful guideline for determining whether a potential house flip is worth pursuing. By limiting your purchase price to 70% of the ARV, you can help ensure that you have enough room in your budget to cover repairs, unexpected expenses, and still make a profit when it comes time to sell.

Understanding the 70% Rule in House Flipping

The 70% rule is a commonly used principle in the real estate industry, especially in house flipping, which refers to buying a property at a low price, renovating or rehabilitating it, and selling it at a higher price. The rule suggests that a real estate investor should not buy a distressed or unrepaired property at a price that exceeds 70% of its post-repair price or after repair value (ARV), which is the estimated value of the property after completing all necessary repairs, minus the costs of renovation. While the 70% rule is a general guideline, and every property is unique, it offers a simple formula to assess the potential profitability of a house flipping investment quickly. A responsible and successful real estate investor must understand what factors contribute to the post-repair price of the property, estimate renovation costs accurately, and know why identifying a maximum purchase price protects their investment.

How to Determine Post-Repair Price (ARV) of a Property

To estimate the ARV of a property, some of the methods used include: Comparative Market Analysis (CMA): An analysis that compares the property to similar properties in the area. By comparing the property’s features, location, and condition to recent sales, an investor can estimate the ARV of the property. Appraisal: A professional appraiser assesses the property’s condition and features to determine its value before and after repairs. Automated Valuation Model (AVM): An algorithmic evaluation system that uses data such as property value, location, price trends, and other market indicators to calculate the property’s value before and after repairs. Regardless of the method used, a real estate investor must be thorough and precise when appraising a property’s post-repair price to make informed financial decisions.

The Importance of Factoring in Repair Costs

Before making a purchase offer, it is crucial to estimate the rehabilitation cost or the amount of money required to repair and renovate the property. A thorough assessment of the required repairs can prevent the investor from underestimating the overall expenses and help identify likely areas of overspending before making any commitments. Thinking ahead and preparing a list of critical systems that need repair or replacement, such as foundation repair, plumbing, and electrical work, can avoid costly surprises once the project begins. Using a construction professional or a contractor can help obtain more accurate figures for repair expenses based on industry standards, current labor rates, and materials costs.

Why the 70% Rule is Crucial for Flipping Success

A house flipper’s profit margin lies in the difference between the purchase price, rehab expenses, and the ARV or final sale price of the property. While some flippers may opt for a higher purchase price, such as 80%-90%, the 70% rule provides a margin of error to ensure that if something goes wrong, the investment still remains profitable. The 70% rule has a sound basis as it helps protect investors from market fluctuations, unexpected expenses, and unanticipated issues that could reduce the property’s profitability. It also helps ensure investors maintain healthy cash flow to finance regular expenses like utilities, permits, insurance, and other necessary carrying costs.

Examples of the 70% Rule in Action

Suppose a flipper wants to purchase a distressed property with an estimated ARV of $400,000 and repairs that cost $100,000. In that case, the maximum purchase price a flipper should offer is $210,000. That is, 70% of $400,000 (ARV) minus $100,000 (repairs). Another example is: A flipper is interested in a home that has an estimated ARV of $300,000 and requires repairs of $70,000. The purchase price should not exceed $161,000, which is 70% of $300,000 (ARV) minus $70,000 (repairs). These formulas will vary depending on the flipping investor’s strategies, income goals, and the location of the investment property.

Potential Risks of Ignoring the 70% Rule

Ignoring the 70% rule presents several potential risks to house flippers, including: Limited Profitability: Purchasing a property above its ARV price and repair costs leads to limited profitability, which can create barriers that prevent successful house flipping. Cash Flow Issues: If a flipper purchases a property with insufficient cash reserves, reduced profitability may lead to cash flow issues that put the entire project at risk. Market Uncertainty: The real estate market is cyclical and can shift quickly. Ignoring the 70% rule may lead to costly project delays caused by changing market conditions that can affect the property’s potential value.

Tips for Applying the 70% Rule to Your House Flipping Strategy

The following tips can help investors apply the 70% rule effectively: Location: Flippers should evaluate location and property condition, including neighborhoods, schools, public transportation, crime rate, and the local housing market. Understand Repairs: Investors should have a thorough understanding of repairs and renovation costs to avoid unforeseen expenses. Budget for Contingencies: Flippers should budget for contingencies by anticipating last-minute expenses that could arise during the remodeling process. Determine a Maximum Offer: Determine the maximum purchase price based on the 70% rule calculation and stick to it. Explore Alternative Financing and Investment Strategies: Investors should consider all financing options, including personal savings, private lenders, or joint venture partnerships, and other alternative investment strategies to meet their goals.

Alternatives to the 70% Rule for Evaluating Property Investments

While the 70% rule is a common strategy for assessing the profitability of a house flip, investors can incorporate alternative approaches to broaden their evaluation. Other models to consider include: 90% Rule: An approach utilized for homes with high value where the investor purchases homes below 90% of the ARV or after-repair value. Cost Plus Margin: A strategy that incorporates the estimated cost of repairs and adds a predetermined margin of profit based on the venture’s level of risk. Reverse Engineering: A method that starts with the investor’s desired profit level and works backward by subtracting expenses to arrive at the maximum purchase price. In conclusion, the 70% rule is an essential strategy for real estate investors, but it should not be the only factor to evaluate a potential house flip project. Understanding the ARV, accurately determining repair costs, and identifying a maximum purchase price can ensure a profitable house flipping project with reduced risk. In addition, exploring alternative approaches can lead to additional investment opportunities and help investors achieve their financial goals.