Whether you are a successful fix and flip investor with multiple projects under your belt, or you are new to the ins and outs of fix-and-flips, there’s a popular term you’ll likely encounter in this business — the 70% rule.
Simply put, the 70% rule is a way to help house flippers determine the maximum price they can pay for a fix-and-flip property in order to turn a profit. The rule states that a fix-and-flip investor should pay 70% of the After Repair Value (ARV) of a property, minus the cost of necessary repairs and improvements.
Because the 70% rule uses such a simple formula, it is a quick and easy way to determine a ballpark purchase amount for a fix and flip property—which is often needed quickly when time is of the essence in the fast-moving fix-and-flip world.
One common mistake, though, is that new fix-and-flip investors automatically assume the “leftover” 30% will be all profit. This couldn’t be further from the truth, because that leftover 30% has to also accommodate the costs associated with purchasing, renovating, and selling the property. These costs could include anything from agent commissions to closing costs, title inspections, and any hard money lender fees. The profit is what is left after all of the costs have been subtracted.
As an investor, the last thing you want to do is overpay for a property. Applying the 70% rule can help you avoid doing so, and help put you in the best position to maximize your profits.
To understand the basic math used to calculate the 70% rule, we’ll use an example of a $150,000 property ARV. If the property is in need of $50,000 in repairs, the 70% rule suggests that the maximum price an investor should pay would be $55,000.
Here’s the calculation:
While the 70% rule is widely used throughout the real estate world, it is a quick guide and shouldn’t be relied upon as the final word for what you should pay for a property. The rule is helpful in giving a quick, rough estimate of what your top offer price for a fix-and-flip property should be, but you’ll also want to be sure and run a more extensive expense analysis as well.
If you’re just getting started in the real estate investment world, the first and most important thing you can do is create a plan. For more information on how to do so, read our blog article about creating a house flipping business plan.
When considering an investment property, you may not be able to access the inside of the home prior to making an offer. If that’s the case, it’s suggested that you use numbers that fall under the “worst-case scenario” in terms of your profit. This will help you avoid getting turned upside down right off the bat on your new investment, and if it turns out better than anticipated, you’ll be that much further ahead.
Another benefit of the 70% rule is that the actual percentage used in the formula can be adapted, depending on the individual investor and the end goal. Everything depends upon the market in which you’re investing, as they differ drastically throughout the country.
To that end, it’s critical that you remain in tune with your specific market, to keep your offers competitive. To help figure out your local market, your best bet is comparing comparable, recently-sold properties around the same area in which you’re looking. If you run the numbers using the 70% rule and end up with a figure that doesn’t match what you were hoping to gain, you can adjust the percentage accordingly and move forward from there.
Should you be venturing into a market that you’ve not invested in before, you must also take into account all the additional costs that are not included in the 70% rule. These costs can include anything from closing costs to property taxes, and depending on where you’re investing, they could end up having a large impact on your final profit margin.
Ready to apply for a fix-and-flip loan from Western Pacific Home Loans? Check out this helpful article on how to get approved.
If you are seeking guidance as you go down the fix-and-flip road, we encourage you to contact the experts at Western Pacific Home Loans. We’re here to answer any and all of your questions, and we look forward to hearing from you soon.
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