When flipping a house, there is a laundry list of general rules that need to be taken into consideration. One rule that should be at the top of your financial checklist is the 70% rule. This post will outline what the 70% rule of house flipping is, and why it may be one of the most important guidelines for making sure your real estate investment is profitable.
What Is The 70% Rule?
Investing in real estate is all about weighing the costs of an investment with the potential net benefit. In order to ensure the greatest return on investment, you will need to use a few simple formulas.
Experienced real estate investors tend to follow the 70% rule. This rule states that a buyer should purchase a property for a maximum 70% of the after-repair value, or ARV, minus the cost of repairs.
The 70% rule is calculated as follows:
Purchase Price = ( ARV × 0.70 ) – Repair Cost
For example, A house flipper wants to invest in a property that is for sale for $350,000. This home has an estimated ARV of $500,000, and has repair costs of $50,000.
( 500,000 X .70 ) – 50,000 = 300,000
To secure the greatest return on investment, the investor would need to negotiate the price down to a maximum of $300,000. If the seller is unable to agree to a lower price, the buyer should consider either cutting renovation costs or finding another property to invest in.
Calculating After-Repair Value
So now that you know about the 70% rule, you might be asking, “How do I know what the home’s after-repair value (ARV) will be?”
Calculating the ARV of a fix and flip requires a simple formula:
ARV = Property’s Current Value + Value of Renovations
The current value of the property may be more or less than the actual price of the property at the time of purchase. This number can initially be roughly estimated by comparing other homes of comparable size and quality in the area, and looking at what they have recently been sold for. Ultimately you should enlist the services of a professional appraiser to help you find an accurate estimate of the value to the property you want to flip.
Keep in mind that the value of renovations is not the same as the cost of renovations: It is the amount of money that the renovations will add to the total value of the home. Read further to learn the difference.
Calculating Renovation Costs
Next, we must calculate the cost of renovation.
To start, decide which areas of the home need improvement, and list out the improvements that need to be made. Research typical costs for appropriate quality of those renovations, and make sure the estimated prices are relevant to the city and state the home is in. Based on these numbers, you can start a rough budget of how much you want to spend. You may want to increase the budget slightly so you have some cushion to account for any unexpected costs or timeline setbacks.
To get your best estimate, it is recommended to hire an experienced contractor who can give their professional advice on the amount of money it will take to get your property into prime selling condition. A contractor will tell you if the repairs you want to undertake are possible to achieve within your set budget.
Beyond the price of the actual repairs to the home, the cost of renovation can include closing costs, property insurance, underwriting expenses, and other assorted fees. Be sure to include these in your budget as well.
Renovation Cost Vs. Value
To estimate how much value your individual renovation projects will retain for resale, check out Remodeling Magazine’s 2021 Cost Vs. Value Report. This report outlines data from both national and regional averages, and will show you the recouped cost of projects such as kitchen remodeling and siding replacement.
The added value of certain renovations can vary greatly by type of renovation and the quality of these fixes. Depending on the location of your house flip, higher quality renovations can add a higher increase in value to the property.
Typically, the value of the repair will not exceed the cost of the repair. It is important that the quality and type of renovations that are being undertaken are appropriate for the area the home is located in. This will ensure that it will match the surrounding community and the taste of potential buyers, and you won’t be spending too much money on needlessly extravagant updates to the property.
Why Do I Need To Follow This Rule?
The 70% rule will help you to determine if the costs associated with a rehab project will give you enough profit to justify the investment.
Depending on market conditions, this rule may not be possible to follow to the letter. You could find yourself paying upwards of 80% ARV (or more!) on a home just to compete with other highly motivated buyers.
To adjust for this, you may need to find areas where you can lower renovation costs with more price efficient materials or less labor-intensive projects.
Keep in mind that these investments typically require a hard money loan to achieve quick funding that competes with the rapid pace of the current real estate market. Not only will you want to ensure a high return on investment for yourself, but also to pay back the loan you took out to pay for it–with interest.
While 70% is not a hard and fast rule, it is a great guideline for estimating how much you should comfortably spend on an investment property.
For more tips on receiving the greatest return on investment for your fix and flip property, visit our resource center. Loan Ranger Capital’s competitive low rates on Fix and Flip Loans can help you finance your next house flipping project in Texas and Tennessee.
Contact us to learn how we can help you to achieve your goals.