What Is the 70% Rule in Real Estate Investing?

The 70% rule is a fundamental guideline in real estate investing, particularly for house flipping. It helps investors evaluate a property’s potential profitability and manage financial risk during acquisition. Investors who purchase, renovate, and sell properties for a return frequently use this principle.

Defining the 70% Rule

The 70% rule states that an investor should pay no more than 70% of a property’s After Repair Value (ARV), after deducting estimated repair costs. This guideline helps establish a maximum allowable offer for a distressed property.

After Repair Value (ARV)

After Repair Value (ARV) represents the estimated market value of a property once all necessary repairs and renovations are completed. This value is determined by analyzing recent sales of comparable, fully renovated properties in the same local market. Accurate ARV assessment requires research into similar properties’ square footage, age, style, and condition.

Estimated Repair Costs

Estimated repair costs include all expenses required to bring the property to its ARV standard. These costs can include structural repairs, cosmetic upgrades, and system overhauls like HVAC, plumbing, or electrical work. Obtaining detailed estimates, often through professional contractors, is important as underestimating these costs can impact project viability.

These two components directly influence the maximum price an investor should pay. The rule provides a structured framework for initial property evaluation. It emphasizes that the purchase price must be low enough to accommodate the renovation investment and yield a return.

Calculating the 70% Rule

The 70% rule calculation determines the maximum allowable offer for an investment property. The formula is: Maximum Allowable Offer = (ARV 0.70) – Estimated Repair Costs. This calculation provides a target purchase price.

For example, an investor identifies a property with an After Repair Value (ARV) of $350,000. Estimated repair costs are $60,000. The investor first calculates 70% of the ARV: $350,000 multiplied by 0.70 equals $245,000.

Next, the estimated repair costs are subtracted from this figure. In this case, $245,000 minus $60,000 results in a maximum allowable offer of $185,000. This is the highest price the investor should offer to adhere to the 70% rule.

This calculation indicates the maximum purchase price that allows for profit and covers renovation expenses. It serves as a benchmark for making competitive offers. Adhering to this calculated offer price helps ensure the project begins with a sound financial foundation.

Purpose of the 70% Rule

Real estate investors use the 70% rule for financial discipline and risk management. It ensures a significant portion of the After Repair Value covers project expenses and generates profit. The rule helps investors make rational decisions when acquiring properties.

The 30% buffer accommodates various costs beyond repairs. This margin covers holding costs, such as utilities, property taxes, and insurance, incurred during renovation. It also accounts for selling costs, like real estate agent commissions (typically 5% to 6% of the sale price) and closing costs (which can average 6% to 10% of the sale price for sellers).

This buffer also incorporates the investor’s profit margin. By adhering to the 70% rule, investors aim to cover all expenses and achieve a profitable outcome. This inherent margin helps absorb unforeseen costs during renovation projects.

The rule also serves as a quick screening mechanism, allowing investors to assess the viability of potential deals. If a property’s acquisition price does not leave adequate room, it can be dismissed, saving time on further due diligence.

Key Considerations When Using the 70% Rule

The 70% rule offers a valuable framework, but its application requires considering contextual factors. Market conditions influence the rule’s flexibility. In competitive markets, investors might adjust their target percentage upward, perhaps to 75% or 80%. In slower markets, a more conservative 60% to 65% might be prudent.

Accuracy

Accurate After Repair Value (ARV) and estimated repair costs are important for the rule’s success. Overestimating ARV or underestimating repair expenses can undermine profitability. Professional appraisals and multiple contractor bids help obtain precise figures.

Other Costs

Investors must also account for other costs not included in the basic 70% rule calculation. These include acquisition closing costs, holding costs, and selling costs. A contingency fund is also advisable to cover unexpected renovation issues.

Property-Specific Characteristics

Property-specific characteristics can warrant deviations from the standard 70% rule. Homes with significant hidden issues might necessitate a more conservative application or a higher profit margin. The rule serves as a starting point, requiring thorough due diligence and adaptability.