What Is The 70% Rule In House Flipping And How Can It Help Me Decide How Much To Pay For A Distressed Property?
Dan Rafter8-minute read
August 07, 2021
What’s the key to flipping houses successfully? Buying homes at a low enough price so that when you sell them you make a large profit. Overspending on the front end of a home purchase will make it much more difficult to earn those big dollars.
But how do you determine when a home’s sales price is right? The 70% rule can help.
It’s important to remember, though, that this rule is just a general guideline and won’t replace the long hours of research you’ll still need to do to make sure you’re not overpaying for a home you want to flip.
What Is The 70% Rule In House Flipping?
Home flippers have a simple plan for earning money: They buy a home cheap, fix it up, and then sell it at a higher price. The goal for flippers is to buy low and then sell high to boost their profits.
The 70% rule can help flippers when they’re scouring real estate listings. Basically, it says that investors should pay no more than 70% of the after-repair value of a property minus the cost of the repairs necessary to renovate the home.
What does this mean? The after-repair value, or ARV, of a property is the amount that a home could sell for after flippers renovate it. When buying a home to flip, investors need to estimate how much they think 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 key here, though, is to realize that the 70% rule is just a general rule of thumb. Before buying any home, you need 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.
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 always work in every market. If you are 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.
In a hot market, then, you might have to tweak your calculations to offer a price that is as high as 85% of a home’s after-repair value minus renovation costs. Will you want to do that? It depends on how hot the market is. You are inviting more risk that you won’t be able to sell your property for a high enough value to earn a profit after you sell. But in a hot seller’s market, you might be able to sell the home quickly and for a bigger price tag.
This is why the 70% rule, as 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.
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What Are Conservative Numbers And Why Should Investors Use Them?
Another way to protect yourself when making an offer on a home that 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. 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?
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, and to include these possible 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 after-repair value. You might think your home, after renovations, will sell for $200,000. 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. Again, this gives you a financial cushion.
If you do plan for the worst, you might end up making more money than expected if repair cost overruns or dips in sales prices don’t happen. That’s OK: You won’t be hurt if you make more money than you expected. But if you make less money than you’ve planned for, that could bring the financial pain.
Show Me The Math: How To Calculate How Much You Should Pay For A Property To Flip
How does the 70% rule work? Say you estimate that your home's after-repair value 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 – you'll get $154,000.
But you're not done yet. You still must subtract your anticipated renovation and repair costs. Say you estimate that 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 how much repairs will cost. If you estimate that you can sell your home for $220,000 after repairs but the market says that most properties in the neighborhood are selling for just $190,000, you might not make the profit you expect. Or maybe you estimate that 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 again eat into your profits.
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.
Is It A Rule Or A Guideline?
Though it’s known as the 70% rule, this pricing strategy is more of a guideline. The number you get after running the 70% rule might not be the right price to offer a seller. Depending on market conditions, you might need to make a higher offer. If you’re buying in a down real estate market, you might be able to purchase your home at a lower cost. The key, as always, is to study market conditions before making any offer.
Know Your Exit Strategy, Or Why The 70% Rule Has Its Limits
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 that have 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, renting it out while you wait for it to increase in value. That’s because 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.
Flipping Houses And The 70% Rule FAQs
Ready to try the 70% rule? Here are the three most important questions you’ll face.
How do I calculate ARV?
The biggest challenge with this 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 profits dwindle as you are forced to sell the property for a lower sales price.
To estimate your ARV accurately, then, it’s important to study the neighborhood in which a home sits and research what comparable properties in the neighborhood sell for. If homes similar to the one you are buying and flipping sell for $180,000, don’t expect to fetch a much higher price when you go to sell.
If you want to flip a home, it’s important to first develop relationships with real estate agents who know the market well and can pull comparable sales for you to use as a guide.
How do I estimate the costs of repairs?
One of the challenges of investing in real estate is estimating how much it will cost to repair or renovate a home. If you’re new to flipping, it’s important to work with a home inspector and a contractor to get a detailed picture of the renovations a home needs and an estimate of how much they will cost.
A home inspector can also advise you on whether there are any serious problems with a home – such as a sagging foundation, mold or a rotting roof – that might make investing in a property overly expensive.
What costs should I include when estimating costs?
Repairs are typically the biggest expenses involved in flipping a home. But they aren’t the only costs you’ll face.
If you are working with a real estate agent to sell your renovated home, you’ll need to pay that professional a commission that will eat up part of your profits. If you are taking out a mortgage to finance the purchase of a home, you’ll need to pay such fees as title insurance and closing costs, which are the fees that lenders and third parties charge to originate and close your mortgage loan. These costs will vary, but you can expect to pay 2% – 5% of your loan amount in closing costs.
Holding costs are another expense. As the name suggests, these are the costs you'll take on while you own a house and before you sell it. These 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 on the state in which your home is located and how long you plan on holding onto it before reselling.
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 profitable. But new investors should realize that this money-making strategy does come with risks. If you’ve never flipped a home before, plan on spending more money than you think while making less than you expect when you sell. As with anything, flipping homes comes with a learning curve. Consider any mistakes you make when starting out as the price of educating yourself on how real estate markets work.
And that 70% rule? Treat it as a rule of thumb. But don’t skimp on detailed research of the neighborhood in which you want to buy, average sales prices in that neighborhood and the average cost of renovating a property there.
If you’re ready to take the plunge, read more about investing in real estate so that you can be as prepared as possible.
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