What is the 70% rule in house flipping?

When it comes to investing of any type, one of the most important things to do is make sure you’re buying your investment at a reasonable price that gives you a chance to turn a profit. The 70% rule is a rule of thumb used by real estate investors who want to flip houses. It states that you should pay no more than 70% of a home’s after-repair value, minus the cost of repairs.

Following this rule can help house flippers avoid losing money on deals and determine when a property is a good investment. We’ll break down the key things to know.

What is the 70% rule in house flipping?

The 70% rule is a guideline used by real estate investors to determine how much they can afford to pay for a home while still being able to turn a profit after flipping it. The rule says that you should only invest in a home if the cost of buying the home, plus any necessary repairs, is 70% or less of the home’s after-repair value (ARV).

For example, if you estimate that a home will be worth $500,000 after you’ve fixed it up, you should pay no more than $350,000 to buy and rehab the property.

One benefit is that the rule can be used in many scenarios. Because it accounts for repair costs, the 70% rule works for deciding how much to pay for a distressed property just as well as it does for any other home.

Limitations of the 70% rule

Though the 70% rule is useful, it’s not perfect. It’s best used as a rule of thumb rather than an infallible way to profit from home flipping. You still need to do the research to come up with a reasonable ARV for a home to make sure you’re not overpaying for the property.

The greatest limitation of the rule is its reliance on estimates. You need to guess at both the cost of repairing the home and the property’s ARV, which can be difficult to do. It also ignores some other costs, such as the cost of getting a loan, market fluctuations, taxes, and more.

What is the 70% rule formula?

The 70% rule uses this formula:

After-repair value x 0.70 – estimated repair costs = maximum buying price for a home

Note that you’ll need to estimate both the repair costs and the after-repair value of the home. Going above the suggested price could put your profits at risk or cause you to lose money on a deal.

How to use the 70% rule to calculate your maximum offer price

Consider this example. You see a home that is in rough shape, but you estimate that it would be worth $220,000 once you did some work to fix it up. You figure the cost of repairs would be about $40,000.

Based on those two numbers, you can figure out how much you’d be willing to pay for the home. You plug those numbers into the formula:

$220,000 x 0.70 - $40,000

$154,000 - $40,000

$114,000 = maximum buying price

If you can purchase the property for $114,000, the 70% rule says you should have a good chance of turning a profit. If you have to pay more, you should stay away.

Will the 70% rule work for me?

The 70% rule is only a rule of thumb; it isn’t perfect. It also requires some amount of experience in the real estate market to be able to accurately estimate the value of a home and how much it would cost to repair.

That’s not to say that it won’t work for you, but there are many factors at play that will influence its effectiveness. You need both experience and to be realistic, not optimistic, with your estimates. Keep worst-case scenarios, such as higher-than-expected repair costs, in mind.

You also need to consider the value of your time. If the profit potential is low and the home will take a long time to rehab, you may want to pass on it. Budgeting extra time for unexpected delays, especially if you need to get permits from your city, is important.

Whether you’re a new real estate investor or an experienced one, you can make the 70% rule more effective by working with a real estate agent and home inspector, who can offer a second opinion on ARV and repair costs.

Finally, keep in mind that the 70% rule focuses on house flipping. It does not work as well for long-term investments, such as buying a home you plan to live in for a few years or that you want to rent out. Market fluctuations and changing conditions can also impact the rule’s effectiveness over longer periods.

What are conservative numbers, and why should investors use them?

One key to making the 70% rule work as a real estate investor is to be conservative when it comes to your estimates for ARV and home repairs. Being optimistic may make more homes look like good deals, but it can also result in you losing money.

In this context, being conservative means planning for the worst-case scenario. You might think a home will sell for $300,000 after you’ve fixed it up, but if the market slows, you might only be able to get $280,000. Similarly, a quick inspection of the home may only turn up $15,000 in needed repairs, but if you uncover a larger issue, you could expect to pay $35,000.

Planning around the worst numbers when you make an offer gives you a better chance of being able to profit from flipping a home.

FAQ

The 70% rule is a popular rule of thumb. Keep these things in mind when using it to help identify home flipping opportunities.

How do I calculate ARV?

After-repair value is how much a home will be worth once it’s repaired. To determine ARV, you’ll have to research the local real estate market and get a sense for how much similar properties sell for. Consider working with an agent who can help you make a good estimate.

How do I estimate repair costs?

Experienced home flippers will likely have a good sense for how much repairs will cost. If you’re new to real estate investing, consider hiring a home inspector or contractor who can help give you an idea of the renovations needed and their cost.

What costs should I include when estimating my house-flipping budget?

When thinking about your house flipping budget, you need to look at more than just the purchase price of the home and how much you can sell it for. Also consider these costs:

• Repairs
• The listing agent’s commission
• Closing costs
• Title insurance
• Holding costs
• Property taxes
• Utilities
• Maintenance

What if the offers I make using the 70% rule are rejected?

Even if you follow the 70% rule, there’s no guarantee the seller will agree to your offer. It also may not work in some markets, especially hot markets where homes are in demand. If your offers get rejected, consider moving on to other deals. Depending on your market, you may also consider going a bit above 70%, but understand there is a risk of making a bad deal.

The bottom line: The 70% rule is a good rule of thumb, but it’s not a substitute for detailed analysis

The 70% rule is an effective rule of thumb that you can use to decide if a property is worth a closer look. It isn’t the be-all, end-all, and is no substitute for truly doing your due diligence about a property to decide if it’s worth investing in. It can guide you to potential deals, but it can’t be used to make the final decision.

If you’re ready to start investing in real estate or buy a home of your own, you can fill out an application to get preapproved for a mortgage from Rocket Mortgage today.