The 70% rule is a formula that investors often use to quickly calculate the maximum purchase price of a fix and flip property. Also referred to as ‘the house flipping formula’, this calculation has a strong connection to property flipping, and is used very frequently.
What Is the 70% Rule Formula?
Maximum Purchase Price = After Repair Value * 70% – Repair Costs
It should be pretty clear that you only need to know two key pieces of information in order to apply the 70% rule, namely the after repair value and the expected repair costs of the property. We will now explain these two elements in greater detail.
The Two Most Important Components of the 70% Rule
1 - After repair value (ARV)
Understanding the value of the property after the renovations have been completed is fundamental to the 70% rule. The quick way to workout the ARV is to simply add the value that you expect the renovations will create to the existing property price, like this:
Simple ARV Formula = Value of property + Value of renovations
However, in order to validate the value of the renovations, it is commonplace to analyze the selling price of comparable properties in the area (comps). This is where an online ARV calculator can be extremely useful.
By simply typing in the address of the property, the calculator will return the last known selling price of several comparable properties in the area. If you want more info on this process, this article outlines how to calculate ARV in more detail.
2 - Repair Costs
The repair costs can make or break a property flip. It is surprisingly common for property investors to overestimate the repair costs, partially due to inexperience, and partially because it makes the safety margin of the deal even greater.
However, if your repair cost estimates are too steep, you might be pricing yourself out of the deal before it ever gets off the ground. For this reason, it makes sense to research all labor and repair costs in detail before inserting your final repair estimate into the 70% rule formula.
70% Rule Example
At this point, it makes sense to use an example in order to see the formula in action. To do so, we will list the property details, and then plug those details into the formula.
- After Repair Value (ARV): $350,000
- Repair Costs: $65,000
70% Rule Formula
- Max Purchase Price = (ARV * 70%) – Repair Costs
- Max Purchase Price = ($350,000 * 0,7) – $65,000
- Max Purchase Price: $180,000
As you can see, using the 70% rule has left us with a final amount of $180,000. You can use this amount as a guideline for your offer, although it will likely require some tweaking to find a number that works for you and the seller of the property.
Why do people use the 70% Rule?
There are a number of reasons to use the 70% rule, but these are some of the primary benefits:
- To quickly work out the maximum purchase price of a property
- To create a shortlist of properties for further cost analysis
- To double check that the costs of a deal fall within recommended guidelines
Ultimately, people use the 70% rule because it is simple to calculate a good target price for the property, and it builds a healthy margin of safety into the deal. You are highly unlikely to lose money if you stay within the boundaries of this rule.
How accurate is the 70% Rule?
It may not give you a perfect picture of the expected costs, but for a quick approximation, it’s surprisingly accurate. That being said, to gain a more complete understanding of all the costs involved, a house flipping calculator can be very useful. The flipping calculator can help you establish loan costs, property taxes, real estate agent fees and other key expenses that you are likely to incur during the flipping process.
Is it okay to break the 70% Rule?
There are two common situations where it can be acceptable to break this rule.
1 – If you are a real estate agent: The main reason real estate agents can get away with breaking the 70% rule is because they can save significant amounts of money by avoiding real estate agent fees when the property is sold. These are typically between 2-5% of the sale price, giving real estate agents an extra bit of leeway that other investors don’t really have.
2 – If you are an experienced property flipper with multiple projects under your belt: Highly experienced property flippers can get away with taking on a bit more risk, and may increase the offer to as much as 75%-80% of the ARV (minus repair costs).
However, if you are still in the early stages of your property investing career, it is best to avoid taking on any unnecessary risks. Staying relatively close to the baseline figure suggested by the 70% rule can help ensure your first flip is profitable, even if you have less experience.
Biggest Risks When Using the 70% Rule
1 – Veering too far off the 70% guideline – The 70% rule is ultimately just a convenient way to stay within relatively safe financial parameters. If you are too aggressive, increasing your offer to 75% or even 80%, you could introduce the possibility of making a loss if the market conditions aren’t favourable when you sell.
2 – Banking on yearly property appreciation – This mistake is best to avoid. If you factor industry based property appreciation into the after repair value estimate, you may end up paying too much for the property. This mistake could then be exacerbated if market conditions take a turn for the worse, and the property actually depreciates over time.
Obviously you need to be confident that your renovations will drastically improve the property value, but don’t add an extra few percent because the general area is trending upwards. Sticking to reliable ARV estimates based on comparable properties in the area can help you avoid this mistake.
3 – Failing to consider all the costs involved in a flip: The beauty of the 70% rule is that it only requires two elements to calculate the maximum purchase price. However, this simplicity could prove to be your downfall if you don’t fully understand all the costs that you can expect with a fix and flip. Again, using a fix and flip calculator can give you a more complete picture of all the expenses that you can expect.
4 – Overestimating repair costs – By overestimating the repair costs, your maximum purchase price may end up being too low for the seller to take your offer seriously. While it is perfectly understandable to be conservative with repair costs estimates, they still need to be realistic.
5 – Underestimating repair costs – The main drawback here is decreased potential for profitability. If you underestimate repair costs, you may end up using significantly more funds than initially expected in order to complete the renovations.
When all is said and done, the 70% rule continues to be a reliable way to create a guideline amount for the maximum purchase price when executing a fix and flip. This method may require additional fine tuning in order to work out the final offer, but when prospecting properties and analyzing deals, it remains a tried and trusted shortcut for property investors.