Arguably the most important part of flipping houses is accurate estimating.
Buying low, getting the property ready fast, and selling higher is the name of the game.Spending too much upfront or overestimating what you can sell a house for can be devastating to your potential profit, which is one factor that makes flipping different from a traditional investment property.
The 70% rule (some people just call it the 70 rule in real estate) can help with this issue.This rule isn’t meant to replace research or be the lone factor you rely on to make a decision, though.It’s just one method to help guide you toward the best possible outcome.
What is the 70% Rule in House Flipping?
The 70% rule of house flipping helps flippers determine a maximum purchase price as they search for real estate investing opportunities. The general basis of the rule is that investors shouldn’t pay over 70% of a property’s after-repair value (ARV) minus the repair costs necessary to improve the property.
The ARV is what a property could sell for after flippers renovate it. Real estate investors estimate a property’s potential selling price and then multiply that number by 70% and subtract that from the estimated repair costs.The resulting number represents the maximum buying price or maximum offer price they should use in order to make a profit on that flip.
Example
Let’s go through an example to illustrate how you might use this rule to decide on a property. Let’s say you’re considering a fixer-upper in a neighborhood that’s growing. Your research shows that well-kept houses in the area sell for around $350,000. You also chat with a local real estate agent who agrees that a house in good condition will probably sell for around a $350,000 purchase price in this neighborhood. Thus, you land on $350,000 for the ARV.
You get a home inspection next and learn that the house needs some plumbing work for $1,500. Between that and the cosmetic adjustments that will cost about $35,000 (and an additional $2,000 just to be safe), you land on $39,000 for repair costs.
So, with 70% of $350,000 coming out to $245,000, and $39,000 taken out for repairs, you decide to offer $206,000.
The profit you want to make is important to keep in mind as well. Many house flippers aim for 10% to 20% of the ARV for their profit margins. The better the work you do upfront, the more likely you are to boost this number.
It’s important to mention that the 70% rule isn’t a hard and fast rule. It can be a useful tool to help discern a property’s potential, but it shouldn’t be the only way you evaluate homes. Studying market conditions, talking with real estate professionals, meeting with contractors, and reading reputable articles are all important parts of the process.Additionally, remember that estimating repair costs does not always lead to an accurate number up front, as additional closing costs, property taxes, and other financing costs (e.g., title insurance) can still apply.
After-Repair Value is Critical
If the 70% rule is going to work for you, one of the most critical pieces is the after-repair value.
If you’re not an experienced house flipper, spend extra time on this step. A professional home inspection could make all the difference. Have an expert look at property and tell you the pain points. They’ll be able to help you determine what repairs are needed, potential pest issues, the foundation’s condition, and more.
Once you have this information, you can develop more accurate repair cost estimates. It may also be wise to get quotes from different plumbers, roofers, and electricians to further solidify estimates.
The more precise you get with this number, the better you’ll be throughout the process. So, it’s important to do thorough research and consult with experts.
What Happens if Your Offer is Rejected
As we’ve alluded to before, the 70% rule isn’t an exact science. And there’s no guarantee someone will leap at the offer just because you utilized the formula properly.
If you’re trying to flip houses in a seller’s market with climbing prices and buyers reacting quickly, an owner is more likely to reject an offer derived from the formula.
Adjustments are a key part of house flipping. If a market is hot and you still want in on it, then you may have to offer something higher than 70%. And you might want to do it anyways if the market is hot enough, and you see an opportunity to still turn a good profit.
The 70% rule isn’t a replacement for research. You need to get to know the market you’re entering and the unique conditions regarding each individual property. There isn’t a template for house flipping that works every time.
Use Safer Estimates
When you flip houses, it’s wise to operate with worst-case scenarios in mind, as much as possible. For instance, if you think a home will cost $50,000 to repair, it might be prudent to put $65,000 in the budget. What if your subcontractors work slower than expected? What if material expenses climb during repairs?
There are a lot of factors that can change as you flip a house. You want to consider delays and cost hikes as very real possibilities. Building this into your budget will give you a better chance for better outcomes.
You may want to approach ARV the same way. If you expect your home to sell for $230,000, you may want to set up the budget as though it’s going for $210,000. You can’t control where market demand will be after your repairs, and you can’t control unforeseen circ*mstances that may impact flipping the house.
We’re not suggesting you assume worst-case scenarios will occur, but always keep them in mind. You’re probably familiar with the under-promise, over-deliver methodology some sales experts employ. Doing that with yourself as a house flipper is wise. This way, if you exceed expectations, it’s a pleasant surprise.
A Few More Notes
This rule works best for people who want to flip houses quickly. If you’re in this group, you can use comparable home sales in the neighborhood to figure out ARV.
The longer you hold onto a property after buying it, the less helpful the 70% rule becomes. It’s quite difficult to estimate worth further into the future.
Lastly, it’s important to keep carrying costs in mind. These holding costs are an expense that you don’t want to forget. Things like homeowners’ insurance, utility bills, and maintenance may need to be covered as you work to prepare the home for selling. These costs rely on the condition the home is in, where it’s located, and how long the home stays in your possession.
Conclusion
Even though the 70% rule isn’t a guarantee, it’s a good way to estimate key financial factors in house flipping. You want to have a number that you won’t go over when looking to buy property for a flip.
Now that you have a better understanding of what the 70% rule is and how it might help you, you can make more informed decisions in your house flipping endeavors.
