You want to get into real estate investing by learning to flip houses. Great, you just need to learn some tricks of the trade to make sure you do not get taken to the cleaners. What is the 70 rule in house flipping? It is a formula that was created by seasoned real estate investors to calculate at what price the need to buy a distressed home.
This is a great rule of you understand how to use it properly. You need to make sure your ARV (After Repair Value) and estimate to do repairs are very accurate. If you are off in either area then the profit will not be there once the flip is complete.
This is not a rule that is set in stone. It is a guideline you use to make sure you are within the range to gain profitability on your flip. If you are a beginner then you should hold fast to the rule and try to bid even lower if possible. The reason is for the beginner you are not as seasoned with issues or hidden cost that may come up on the rehab. You want to make sure you have enough in the profit to take a few hits that you had not expected.
The seasoned investor will be able to know more about the pitfalls. They will be able to be more competitive on buying because they have streamlined rehab cost by doing rehab faster or lowered their lender cost. The rule is something you want to be close to if new and can be more liberal with if you are a seasoned investor.
What is the rule
(ARV (After Retail Value) x .70) – Estimated Rehab Costs = Price to Pay
We can look at a few examples:
You are looking at buying a house that is discounted at $150,000 and the rehab to get the house in excellent condition is $25,000. You just plug the numbers into the formula assuming you know the ARV which is $275,000.
($275,000 (ARV)x.70) -$25,000 Rehab costs = $167,500
$167,500 is the most you can pay for this property according to the 70 rule.
You find a bank-owned property for $350,000 with the rehab cost you have estimated at $79,000. The house brand new on the market would have an ARV of $475,000.
$475,000 x .70 = $332,500 then you minus rehab cost $79,000 this equals $253,500
This deal would not be a good deal unless you can get the price of the home lowered and you also need to get the rehab cost less. You do not want to cut corners on doing the rehab but maybe the contractor can lower the cost. To make this deal happen you would need to find $96,500 in owner lowering the price or in contractor labor to rehab the home. If you can’t get close then just walk away from the deal. Never take a deal if the numbers are not there.
This is a foreclosed property that you found for $195,000. The rehab costs you have estimated at 34,000 to do everything you want. We can once again just plug in the numbers knowing the ARV is $318,000.
$318,000 x .70 = $222,600 then just subtract the rehab and we have $188,600
This is only $6,400 dollar difference which might be enough to do a deal. Can you lower the price on the home or increase the ARV just a little. These are the things you need to consider when looking at houses and doing the 70 rule.
You are buying a house that only needs cosmetic repairs. The house cost $100,000 for you to buy from a bank. The repair cost is only $9,000 to get this house back on the market. The ARV for this area of town is $145,000 in good condition.
$145,000 x .70 = $101,500 you subtract rehab costs of $9,000 and you get $92,500
This is really easy so cosmetic rehab should take weeks not months. Your holding cost will be much lower so this home you can buy higher and still make some quick cash. Do not count out these quick flip properties. They are harder to come by but very quick to do and lucrative for the effort.
You make money when you buy
The key to flipping homes is finding the home you can buy that is distressed at a price you can profit after rehab. If you buy the home at the wrong price you will be lucky to break even. You may also lose your shirt if you are way off on ARV and rehab costs.
If you are off slightly on the ARV or rehab costs then you may just make less profit on the flip. I have done this before where I made a mistake and we only made $4,000 on a flip we did. It comes with the territory you will make mistakes when you start doing house flips. The key is to limit your mistakes and maximize your profit.
Golden rule never buys a house based on you love it or emotion. Throw that out when buying homes all that should matter is the numbers. If the numbers do not work in the home you are looking at then you need to walk away.
Major and medium-sized cities
Every market and city is different when it comes to flipping. You really need to know your city the prices that houses are getting in your specific area. Some cities prices can significantly drop from one block to the next. If you are not aware of this you could have the ARV wrong by a large margin so when you buy you will end up losing your shirt on the deal.
Really competitive areas of the country like Las Vegas or California cities such as San Francisco, LA and San Diego you are not going to get a house at 70% discount. You may have to buy the homes at 75% or 80% of ARV.
It may be beneficial to get a realtor on your team that will help you with the ARV in your market. You will need a good one anyways when you want to sell the home you just rehabbed. If they work out-promise them more deals if they help you understand the local market. You need to have partnerships in this business to buy, borrow and sell homes.
The 70 rule may not work everywhere like we discussed above. You want to make sure you stay out of rental markets when buying. You will also have competition against landlords. The like discounted homes but do not have all the costs you do. They can buy the homes for more money, do just enough rehab to rent it out, and then hold for renting. This makes it tough to get great homes so that means you have to do volume. You have to do a bunch of marketing to find deals before anyone else does.
Throw out rule 70
The rule 70 is a great guideline but remember it all comes down to numbers. You could buy a house at 25% of ARV and still lose money because the repairs are more than the overall resale value. You can also buy a home at 86% of ARV and still make money because the home only needs cosmetic repairs.
The rule is something you need to be aware of but the key is making sure you know the ARV of the area and you calculate rehab costs correctly. You miss anyone of these estimates by a large margin you will not be profitable or will lose money.
When I first started flipping homes I was ok with making a smaller margin to learn the business. The one thing I could not afford was a huge loss.
There are several different margins you can go with when it comes to flipping a home for profit. The trick is to make sure your beginning numbers are correct. If you are not sure about the numbers you have for ARV and for the overall rehab get second bids or advice. There is no reason you can’t ask 2 or 3 realtors what they think the price would be for a house you are renovating. You just give them the information on size and bedrooms plus the rehab you are doing. They will come back with a number they think will work. Take the three numbers from each realtor to look at your price point. Go with the higher one because you can always negotiate down but you can’t negotiate up in price.
Hopefully, the 70 rule in real estate flipping will help guide your purchase. Once you get good at flipping then you can be flexible on the price to buy.