What Is The 70% Rule In House Flipping And Does It Show How Much To Pay For A Distressed Property?

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.  

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.