One of my kids’ teachers, Mr. Warren, took me aside after our parent-teacher conference the other day to ask what the ‘70 Rule’ in house flipping is. Interested in pursuing a part-time career in real estate investing, he’d started doing some research on buying and holding properties as rentals only to decide that being a full-time landlord wasn’t for him. Flipping houses, on the other hand, seemed both manageable and potentially profitable—assuming he could successfully grasp the rules of the game.
Having been a real estate investor for many years now, I could confidently say that it’s certainly possible to make a good business out of flipping houses. But, I am not convinced that following these types of hard and fast rules is the way to do it. So, I told him once he wrapped things up for the day, I’d be happy to help him wrap his head around the ‘70% Rule’ as well as other, possibly better, rules of thumb to consider when investing.
What is the 70 Rule in House Flipping?
The ‘70% Rule’ refers to a formula that many real estate investors use to determine the price they should pay when they find a fixer-upper home for sale that they intend to rehab and resell. This number is critical for making a profit in house flipping. If you pay too much for a house in the beginning, you could really pay for it on the sell-side when the returns you wanted don’t come to pass. And, if the market won’t bear it, you can’t raise your asking price to compensate for a high buying price. Hold out for a higher price and you may not be able to sell your investment property at all.
So, the 70% rule was created to help you buy a property at a number that leaves room for realizing a return on your investment (ROI). The rule states that you should only pay 70% of a property’s after repair value (ARV), minus your costs to rehab, if you want to see any returns. Otherwise, you risk thinning out your profits if you see any at all. Here’s the formula:
(ARV X .70) – Rehab Costs = Maximum Purchase Price
To illustrate, let’s take a look at a home with an ARV of $200,000. Using the 70% rule, you would first multiply $200,000 by 70%, or .70. Next, you would subtract all of your repair and renovation costs, from the removal of old carpet in the bedrooms to the addition of new appliances in the kitchen. Assuming you were able to perform a home inspection and confirm that you weren’t at risk of buying a money pit, let’s say your rehab expenses top off at about $34,000. With those numbers in mind, you could potentially go as high as $110,000 on your offer. Here’s the formula with our numbers plugged in:
($200,000 X .70) – $34,000 = $110,000
A word of caution is necessary here. Be wary of a variation on the 70% rule that has you calculate the numbers a bit differently. This version, taught by some ‘gurus’ out there, suggests you subtract your rehab costs from the purchase price and then multiply by 70%. This skews the results by factoring in less than 100% of your expenses. Using the example above, let’s see how this plays out.
(Purchase price – rehab costs) X .70 = Maximum Purchase Price
$200,000 – $34,000 X .70 = $119,000
The second variation of the ‘70% Rule’ suggests that you have an extra $9,000 to offer the homeowner. This difference can affect how much money you can make flipping a house—or, whether or not you can possibly break even.
Even if you use the correct formula, you’ve got to ensure that all of your numbers are right. That means you have to be able to correctly assess your property’s ARV and evaluate the cost of repairs. To estimate the ARV you need to have some understanding of your local market and know how to compare homes of similar size, style, age, and condition that have recently sold nearby. And, in order to accurately account for the renovation, you’ll need to know a thing or two about local material and labor costs or get multiple estimates from individual experts. It’s not a bad idea to have a real estate investment valuation tool on hand that covers all those bases to help you run your numbers. All of these points are critical to keep in mind since, if your calculations are wrong, there is no known rule that’ll rescue a bad deal.
Additionally, there are other factors to consider when making an offer on a property. If houses aren’t selling in a particular neighborhood, for example, then it’s not going to matter what percentage you’re at. Or, if a neighborhood is on the rougher side of town, you may not be able to sell it for much more than you bought it—even if it is the nicest house on the block. Location is important when you’re buying, renovating, and selling houses for a profit. But, so is how you renovate, for whom, and during what season. So, if you create a cool bachelor pad where mostly established families and retirees buy, then try selling it during the winter because you rehabbed it during the fall, you could end up holding it so long that your returns come in at zero.
Rather than adhere to one rule of thumb when trying to figure out the ideal price of buying a property, consider all of the elements that might affect your numbers. And, when it comes to those numbers, consider the cost of miscalculating them—then, go out and get access to some of best tools to make sure that you don’t.
A Better Rule of Thumb is to Have the Best Tools
Like Gerald, I started investing part-time while working in another field. Unlike Gerald, I didn’t do nearly as much research on how to successfully build a business by flipping houses. Instead, I read about the ‘70% Rule,’ then ran right out and tried to implement it on my first deal. And, since I miscalculated my rehab costs and paid too much for the house, that first deal fell flat. Had I not become an independently owned and operated HomeVestors® franchisee shortly thereafter, my career might have flatlined, too.
By joining the HomeVestors team, I gained immediate access to HomeVestors®’ proprietary analysis and valuation software, ValueChek™. So, correctly calculating repair costs became much easier, which made buying houses at the right price less of a challenge. When you’ve got a great tool like ValueChek™, you’ve got a great chance to make a solid career out of investing in real estate. And, that, is a much better rule of thumb for realizing good returns than following any hard and fast house percentage formula.
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