Understanding the 70% Rule in House Flipping
For house flippers, the 70% rule is a guiding principle that helps estimate the maximum price you should pay for a property to turn a profit. While not a hard-and-fast rule, it provides a solid framework for making smart investment decisions. This guide will break down the 70% rule and show you how to apply it.
What is the 70% Rule?
The 70% rule states that an investor should pay no more than 70% of the After Repair Value (ARV) of a property, minus the estimated repair costs.
The formula is:
Maximum Purchase Price = (ARV * 0.70) - Estimated Repair Costs
Breaking Down the Components
After Repair Value (ARV)
The ARV is the estimated value of a property after all repairs and renovations are completed. To determine the ARV, you need to look at comparable properties (comps) in the area that have recently sold. Comps should be similar in size, style, age, and condition to what your property will be after the renovation.
Estimated Repair Costs
This is the total amount you expect to spend on renovating the property. It's crucial to create a detailed budget that includes materials, labor, and a contingency fund for unexpected issues. Get quotes from multiple contractors to ensure your estimates are accurate.
How the 70% Rule Protects Your Profit
The remaining 30% of the ARV is intended to cover your other expenses and your desired profit margin. This typically includes:
- Holding Costs: Property taxes, insurance, and utilities while you own the property.
- Closing Costs: Fees for buying and selling the property.
- Financing Costs: Interest and fees on any loans you take out.
- Your Profit: The money you make after all expenses are paid.
By sticking to the 70% rule, you build a buffer to protect your profit from unforeseen expenses and market fluctuations.
An Example of the 70% Rule in Action
Let's say you find a property with an ARV of $300,000, and you estimate the repair costs to be $40,000.
Maximum Purchase Price = ($300,000 * 0.70) - $40,000
Maximum Purchase Price = $210,000 - $40,000
Maximum Purchase Price = $170,000
According to the 70% rule, you should not pay more than $170,000 for this property to ensure a profitable flip.
When to Adjust the 70% Rule
The 70% rule is a guideline, not a law. You may need to adjust it based on:
- Market Conditions: In a hot seller's market, you may need to go up to 75% or 80% to be competitive.
- Your Experience Level: Experienced flippers with established contractor relationships may be able to work with tighter margins.
- Your Desired Profit: If you're aiming for a higher profit, you may need to use a lower percentage, like 65%.
By understanding and applying the 70% rule, you can make more informed decisions and increase your chances of success in the competitive world of house flipping.
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