Home improvement shows make flipping houses look so simple, don’t they? You buy a cheap home, slap some fresh paint on the walls, and then you turn around and sell it for a huge profit, right?
While house flipping may occasionally work this way – let’s not make the exception the rule. The reality is that this kind of real estate investing usually takes a lot more planning and management from the start. And that’s where the 70% rule (sometimes referred to as the 70 rule) comes in.
The 70% rule is a tool you can use to plan for the best return on your house flip. It helps motivated real estate investors – like yourself – balance home purchase prices and repair costs and make a profit.
To get the most from your real estate investment, get the 4-1-1 on the 70% rule.
What Is The 70% Rule?
If you’ve spent enough time watching house-flipping reality shows (or love someone who does), you’re probably familiar with the basics of house flipping: Buy a fixer-upper, do some simple renovations then sell the house for a profit. In other words: buy low, increase value, sell high.
But, as a house flipper, how low do you have to go when buying a home so you can better ensure a decent profit on the resale?
Enter after-repair value (ARV). ARV is the value of a property after it’s been repaired and renovated. This is an estimation of the property’s market value based on its repairs.
According to the 70% rule, the most you should pay for a home is 70% of its ARV, which would leave you with about a 30% profit margin. The 70% rule helps home flippers calculate profit margins for the properties they want to buy.
The 70% rule can help eliminate homes that don’t match your budget criteria for a profitable home flip as well as help gauge the profit or repair cost potential of homes that do fall within your budget range.
Spoiler alert: The 70% rule isn’t a hard-and-fast rule. There are plenty of other market variables to consider when you’re trying to maximize your returns. Use the 70% rule as a guideline and starting point but make sure to research the market you’re in, too.
How Do I Use the 70% Rule?
The 70% rule comes with a formula to help you determine a property’s max purchase price.
After-repair value (ARV) x 0.7 – estimated repair cost = max purchase price
The max purchase price will give you a rough idea of the most you should pay to buy a fix-and-flip. If you pay over that max value, you might risk flopping on the profit end of the formula.
For instance, your ARV might be $200,000, but comparable properties in the market are selling for $170,000 or less. You might not make the profit you’d otherwise expect.
Creating a house-flipping budget
Repair and renovation costs can be hard to predict. If you’ve ever done any significant home repairs, you know that costs can escalate and escalate quickly. Be generous when estimating your repair costs, which can include labor and materials.
Making room in your budget for the unexpected improves your chances of staying on budget and getting a reasonable return on your property investment.
Let’s say you budget $15,000 for repairs, but the repairs wind up being more expensive and time-consuming and end up costing $25,000 instead. If you didn’t make room (or enough room) in your budget, that extra $10,000 you spend will come right out of your profits.
Pro tip: Talk to local real estate experts, contractors and other professionals to estimate a realistic number for the cost of repairs and the home sale price.
With these variables in mind, let’s apply the 70% rule to a property with a $200,000 ARV and $25,000 in estimated repairs:
ARV $200,000 x 0.7 ($140,000) – estimated repair cost ($25,000) = $115,000
According to the 70% rule, you shouldn’t pay more than $115,000 to buy this home if you want to make a reasonable profit. Sometimes a listing might match your max purchase price, but in other cases, your max purchase price might be lower than the seller’s asking price.
What Happens if My Offer Isn’t Accepted?
Unfortunately, a seller may not be persuaded to sell their home to you based on your profit-making calculations. After all, they’re trying to maximize their profits, too.
So, what’s a house flipper to do if a seller rejects their offer?
- Consider the market: If it’s a seller’s market, where demand for homes is high, sellers are likely getting multiple offers and can demand a higher purchase price.
- Increase your bid: You might need to offer more money or agree to a counteroffer as high as 85% of the ARV minus estimated repair costs. If you flip the home quickly enough and it’s still a seller’s market, you might be able to sell the property for more than your asking price. You could also increase your purchase offer and ask the seller to perform some of the repairs to reduce your estimated repair costs.
- Revisit your repair costs: You shouldn’t underestimate your repair costs, but it can be easy to overestimate them, too. Make sure your repair budget is generous – but realistic.
You and the seller may not agree on a purchase price that falls within a reasonable range of your 70% rule outcome. That may mean one of two things – either you need to do more market research to figure out what factors make this property’s value higher than you originally determined, or you need to move on to another home that fits your house-flipping budget.
Considerations for Adjusting the 70% Rule
Keep in mind that the 70% rule is a guideline. It’s a formula that can help guide you. In some cases, it’s perfectly okay to stray from the rule if there are other ways a property can offer a good return on investment.
The 70% rule is generally intended for flippers looking to sell, renovate and flip a home in a relatively short time frame. If you’re willing to risk a little more in a hot seller’s market, you can be more aggressive with your purchase offers. Just make sure you’re considering all the costs associated with buying a home before you commit to a higher bid.
Sometimes the 70% rule can’t anticipate the additional costs of buying a property. Remember, you’ll be responsible for other expenses, like real estate agent commission, insurance, closing costs, financing costs and basic home maintenance.
After applying the 70% rule to the property you want, you might find that these associated costs put your investment into riskier profit margin territory.
If you’re willing to wait out your investment for a while, you might see larger returns on a property that doesn’t meet the 70% rule. You might hold onto a property instead of selling right away, hoping to one day bank on building equity through property appreciation, a better market or rental income. In any case, it’s hard to guess exactly how much a property will be worth in 5 or more years.
Rules Are Rules – or Are They?
Rules aren’t made to be broken, but it might be worth it when it comes to the 70% rule. While the 70% rule is a great guideline to jump-start your house-flipping journey, it might not always reflect all the variables involved in successfully flipping a home for a profit. Start with the rule, but crunch your numbers alongside expert advice before you commit to a deal.