What Is The 70% Rule In House Flipping And Does It Show How Much To Pay For A Distressed Property?
Dan Rafter9-minute read
April 21, 2023
A key component of flipping a house successfully is buying the property at a low enough price that you reap a large profit when it comes time to sell. Overspending on the front end of a home purchase can make it extremely difficult to earn back as much or possibly more than you put into the house.
But how do you determine when a home’s sales price is right? The 70% rule can help.
Keep in mind that the 70% rule is just a general guideline and won’t replace the research you’ll need to do to ensure you’re not overpaying for a home you want to flip. Let’s explore the ins and outs of the 70% rule and how it works in house flipping and real estate investing.
What Is The 70% Rule In House Flipping?
The standard process for flipping a house involves buying a home or distressed property at a low purchase price, fixing it up and selling it for a higher amount. The goal for house flippers is to buy low and then sell high in order to boost their profit.
The 70% rule can help flippers when they’re scouring real estate listings for potential investment opportunities. Basically, the rule says real estate investors should pay no more than 70% of a property’s after-repair value (ARV) minus the cost of the repairs necessary to renovate the home.
The ARV of a property is the amount a home could sell for after flippers renovate it. When buying a home to flip, investors need to estimate how much they believe the property could sell for after it’s been renovated. They can then multiply that amount by 70% and subtract it from the estimated cost of renovating the property.
The resulting figure is the highest price that flippers should consider paying for that property.
The 70% rule is just a general rule of thumb, however. Before buying any home, you’ll want to study market conditions, work with real estate professionals to get a more accurate resale estimate, and meet with contractors to determine how much repairs will cost and which renovations are needed.
If you’re getting a mortgage to finance the investment property, you’ll also want to consider the loan amount and term when evaluating your overall expenses and the ARV of the property. Make sure to apply for mortgage approval so you can understand how much property you can afford before you go house hunting.
Securing mortgage approval can also help you prepare to pay back the mortgage once the property is ready for resale, because you’ll know how much you owe your lender.
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The 70% rule helps home flippers determine the maximum price they should pay for an investment property. Basically, they should spend no more than 70% of the home’s after-repair value minus the costs of renovating the property.
How Does The 70% Rule Work?
The 70% rule relies on a simple calculation:
After-repair value (ARV) ✕ .70 − Estimated repair costs = Maximum buying price
That maximum buying price will give you an idea of how much you should spend on a home that you plan on renovating and reselling. Going above that price could jeopardize your profits.
What If The Offers I Make Using The 70% Rule Are Rejected?
The 70% rule doesn’t work in every market. If you’re buying a home in a seller’s market where home prices are soaring and buyers are snatching up homes quickly, an owner might not accept your offer even if you arrived at it by using the 70% rule.
If market conditions are hot, you might have to tweak your calculations to offer a price that could be as high as 85% of a home’s ARV minus renovation costs. Whether you want to take this approach depends on the competitiveness of the market. You could be making it more likely that you won’t be able to sell your property for a high enough value to earn a profit after you buy and renovate.
But if you’re selling the property in a hot market, you might be able to sell the home quickly and for a bigger price tag.
This is why the 70% rule, useful as it is, is no substitute for researching market conditions. You might even find yourself in a buyer’s market, a time when homes aren’t selling quickly and prices aren’t rising. In that case, you might offer a lower price for a home even if the 70% rule tells you to offer a higher one.
What Are Conservative Numbers And Why Should Investors Use Them?
Another way to protect yourself when making an offer on a home you want to flip is to use conservative numbers.
In this context, “conservative” means planning for the worst-case scenario. This is helpful when estimating repair costs. For example, you might think it will only cost $50,000 to renovate the home you want to buy. But what if there are delays with subcontractors? What if you discover additional problems when you rip open your new home’s walls? What if material costs rise during the renovation?
Plenty can go wrong with renovating a home. It’s important to plan for delays and cost increases when you take on any renovation project. It’s also paramount to include these potentially higher costs in your repair budget. If you think repairs will cost $50,000, you might want to budget $70,000 to give yourself a financial cushion.
The same holds true when estimating your home’s ARV. You might think your home will sell for $200,000 after renovations. But what if demand cools while you’re renovating? What if other nearby properties hit the market with lower price tags? These unknowns could cause your home’s after-repair value to fall.
Again, it’s important to plan for the worst when estimating the final sales price of your renovated home. Maybe you expect your home to sell for $200,000 but budget as if your home will only sell for $180,000.
If you do plan for a worst-case scenario, you might end up making more money than expected. This could happen if sales prices on comparable properties remain steady or you don’t spend as much money on repairs as you projected.
How To Calculate How Much You Should Pay For A Property To Flip
Let’s say you estimate that your home’s ARV will be $220,000. To get a rough estimate of how much you should pay for that property, multiply that $220,000 figure by 0.7, and you’ll get $154,000.
Then, you’ll subtract your anticipated renovation and repair costs. Let’s say you estimate it will take $40,000 to renovate your new home before you resell it. Subtract that $40,000 from the $154,000 figure and you are left with $114,000. That figure is the estimated maximum price you should spend on your new home, according to the 70% rule.
To make the 70% rule as effective as possible, it’s important to be realistic with both your after-repair value and your estimate of repair costs. If you estimate that you can sell your home for $220,000 after repairs but the market says most properties in the neighborhood are selling for just $190,000, you might not make the profit you expect. Or maybe you estimate repairs will cost $40,000 but when it’s actually time to renovate, you spend $60,000. That extra $20,000 you’ve spent will eat into your profit.
It’s important to work with real estate agents, home inspectors and contractors when flipping a home. They can guide you to a more accurate assessment of how much your home will cost to repair and how much it might fetch when it’s time to sell.
If you’re financing the home purchase with a mortgage, applying for an initial approval can also give you a better picture of what you can reasonably afford to spend on a house. With an initial approval from a lender, you’ll have an idea of how much you can budget for renovation costs and, eventually, list the house for when you put it back on the market.
Will The 70% Rule Work For Me?
Depending on your goals, the 70% rule might not work for you. This rule generally only works for investors who want to renovate and flip a home quickly. These investors are often buying in neighborhoods with plenty of comparable home sales that can help them determine a more accurate after-repair value.
The 70% rule doesn’t work as well if you want to buy a home and hold onto it for years, perhaps renting it out while you wait for its value to increase. It’s difficult to guess how much a home will be worth in the future, and if you can’t accurately predict a home’s after-repair value, the 70% rule loses its value.
FAQs About The 70% Rule And House Flipping
Are you ready to try the 70% rule? Here are answers to a few questions you may still have.
How do I calculate ARV?
The biggest challenge with the 70% rule is coming up with an accurate figure when you calculate ARV. If you overestimate your home’s after-repair value, you could watch your profit dwindle as you’re forced to sell the property for a lower sales price.
To estimate your ARV accurately, it’s important to study the neighborhood where a home is located and research how much comparable properties there sell for. If homes similar to the one you’re buying and flipping sell for $180,000, don’t expect to fetch a much higher price when you go to sell. Keep in mind that a real estate agent may be able to help you find real estate comps to help establish your ARV.
How do I estimate the costs of repairs?
One of the challenges of real estate investing is estimating how much it will cost to repair or renovate a home. If you’re new to flipping, consider working with a home inspector and a contractor to get a detailed picture of the necessary renovations and how much they will cost.
A home inspector can also advise you on whether a home has any serious issues – such as a sagging foundation, mold or a rotting roof – that might make investing in a property more expensive.
What costs should I include when estimating my house-flipping budget?
Repairs are typically the biggest expenses involved in flipping a home or distressed property. But they aren’t the only costs you’ll face.
If you’re working with a listing agent to sell your renovated home, you’ll need to pay them a commission. If you’re using a mortgage to finance the home purchase, you’ll need to pay fees like title insurance and closing costs to your mortgage lender and other third parties. These costs will vary, but you can expect to pay 3% – 6% of your loan amount in closing costs.
Carrying costs, also called holding costs, are another expense. As the name suggests, these are the costs you’ll take on before selling a house you’ve purchased. Carrying costs could include homeowners insurance, property taxes, utility bills and any property maintenance you need to do before flipping your property. The amount you’ll pay in holding costs depends in part on the state where your home is located and the amount of time you plan to hold onto the home before reselling.
The Bottom Line: The 70% Rule Is A Good Rule Of Thumb, But It’s Not A Substitute For Detailed Analysis
Flipping a home can be a profitable endeavor, but new investors should understand that this real estate investment strategy carries risks. However, using the 70% rule can be helpful in determining how much you should be spending on a house or distressed property if you hope to make a profit when you resell.
Again, treat the 70% rule as a rule of thumb. Do your research of the neighborhood where you’re looking to buy and consider average sales prices in that neighborhood as well as the average cost of renovating a property there.
Are you ready to take the plunge on an investment property or house-flipping project? Before diving in, you’ll want to determine how you’re financing the home purchase. Apply for initial mortgage approval with Rocket Mortgage® today.
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