If you are new to real estate investment, you could not be knowing the amount that you should offer on a property. The 70% rule in the real estate industry gives new investors an easy guideline. This article will help you to learn what is the 70% rule in house flipping.
You don’t want to get yourself in a position where you overbid for a property. You can overwhelmingly make or lose your profits when buying a property depending on the amount that you pay. The insights that you get here will help you to make informed decisions in the industry.
- 1 The 70% Rule in House Flipping:
- 2 Applications of the 70% Rule in Real Estate:
- 3 The Mathematics Behind the House Flipping Deal:
- 4 Is the 70% Rule in House Flipping Accurate?
- 5 Your Target Profits and Labor:
- 6 One Reason You Should Never Break the 70% Rule on House Flipping:
The 70% Rule in House Flipping:
As you think about the maximum price to pay for a property, the 70% real estate rule states that you shouldn’t pay over 70% of the ARV (After Repair Value) less the repair costs. The next thing to understand here is the meaning of ARV in real estate investment. It refers to the estimated value of a property after completing all the repairs.
Suppose the ARV value of a property is $100,000 and the required cost of repair is $25,000. According to this rule, the maximum that an investor should pay for such a property is $45,000. 70% of $100,000 is $70,000 minus $$25,000 you will get $45,000. When you chop out the 30%, you will leave room for both your miscellaneous costs such as soft costs and your profits.
With this information, you now have a clear picture of what is the 70% rule in house flipping. However, this rule is far from written in stone. It is a misnomer word rule and a loose guideline that offers a fast shorthand for reference framing.
Applications of the 70% Rule in Real Estate:
The 70% Rule is highly beneficial in house flipping as it will help you to instantly evaluate if a potential deal is a correct ballpark. However, you should not make all the offers based on the 70% rule on house flipping. Nevertheless, it is a simple framework that will help you to evaluate the prospective deals.
What makes the 70% rule in house flipping an effective guideline is its element of simplicity. It allows you to ignore all the other things apart from the two most important numbers when looking at a deal for the first time. These include the repair costs and the ARV.
If you make an accurate forecast of these numbers, you eliminate the chances of losing your money on a deal. However, if you get the repair estimate costs and ARV wrong, you can lose tens or even thousands of dollars easily.
Make sure you get these numbers right before you determine the amount you will pay for your property. The next thing you need to do is to analyze the comps in the market with a lot of detail. You also need to get the opinion of the Realtor on the ARV. If the comps mirror the said property less closely, you should consider the ARV estimate less accurate.
Based on the estimated repair costs and ARV, you may work backward in determining the most ideal offer price. How much you offer will determine your profits from the real estate deal. The good thing about the 70% rule is that it directly cuts to the most critical numbers in any house flipping deal. It forces you to pay very close attention to these important numbers.
The Mathematics Behind the House Flipping Deal:
It is good to compare how the 70% Rule holds up in comparison to the other detailed analysis. It is a more detailed deal and ROI analysis. The investor includes expenses such as the carrying costs, settlement, costs, and the other soft costs that are associated with an investment in real estate. Experienced real estate investors also know how to budget for the unforeseen repair costs so that they don’t come by surprise.
Is the 70% Rule in House Flipping Accurate?
The 70% Rule in house flipping makes easy and fast shorthand and it should only remain as a starting point. After a more detailed expenditure analysis, you will discover that this rule tends to fall short of the mark. In real life investment in real estate, you may only be willing to invest 60% of the ARV less the cost of repairs. In other cases, you may be willing to offer 75% or even 80%. Here are some of the factors that can influence how much you can offer in practice;
The Market Price Point
In low-end property markets, you will get into additional risks and expenses that will affect your investment strategy. For instance, you can have a high risk of stolen equipment and appliances, vandalism, and break-ins. You can lose a lot of money in crime-related activities when you invest in low-end real estate markets.
Some settlement costs are also fixed and don’t depend on the sales or purchase price. The lender can charge a minimum fee of $3,000 or three points whichever is higher. Most of the title-related charges are fixed and don’t depend on the sales price. That implies that as a percentage of the deal, they will be more than the expensive deals. On the contrary, the high-end deals usually come with less expenses and headaches.
The 70% rule is a useful shorthand to flip houses but it is less applicable in the other exit strategies. Rental investors may not innovate the building that extensively and will hold the property in the long run. The reason is that their primary goal is the cash flow and not a one-time payout that is based on ARV. Their calculations normally resonate around the annual income and yield.
Similarly, in case you are wholesaling deals, their numbers may appear different to you. ARV and repair costs are still crucial but in case you have a strong purchase list, and understand that your buyers may pay higher than the contract price, the rule is less important than knowing your market and buyers.
Your Target Profits and Labor:
Some deals will require you to do more work than others. We have investors who want to earn more profit for every deal than others. If you come across a deal that involves a quick turnaround time, and minimal work, you may accept a lower profit margin by capitalizing on the high velocity of money and pay higher than the 70% rule dictates.
One Reason You Should Never Break the 70% Rule on House Flipping:
As we have mentioned above, there are so many reasons to buy lower or higher than the 70% rule suggests. However, you should never break this rule on the assumption of appreciation. The prices of real estate don’t always rise. An excellent example is the 2008 housing crisis where the values of real estate dropped. It is a crucial point to consider as you seek to understand what is the 70% rule in house flipping.
With all this information, you have a clear understanding of what is the 70% rule in house flipping and when to apply it. You need a more detailed expenditure analysis as you make an offer. This knowledge will help you to make more informed decisions when planning to invest in real estate.