The 70% Rule in House Flipping

In the intricate world of real estate investment, the 70% Rule in house flipping emerges as a critical benchmark. This isn’t just a suggestion but a strategic framework guiding investors on the upper limit they should pay for a distressed property. This comprehensive guide aims to delve into the nuances, offering seasoned investors a detailed understanding of its application, implications, and limitations in the dynamic real estate field.

The essence of the is encapsulated in a simple formula: an investor should pay no more than 70% of the After Repair Value (ARV) of a property, subtracting the costs of necessary renovations.

Formula Expanded: MaximumPurchasePrice=(ARV×70)

Dissecting the Key Elements

• After Repair Value (ARV): This projection of the property’s value post-renovation. Determining ARV is complex, requiring a granular understanding of the property’s locality, comparative market analysis, property dimensions, and the value added by specific renovations.
• Cost of Repairs: This includes all expenses related to refurbishing the property to achieve the ARV. It’s not just about the obvious costs like materials and labor; it also encompasses permits, professional fees, and a contingency for unexpected expenses. Accurate cost estimation is crucial and often demands professional assessments or experience in renovation.
• Gather Local Data: Costs vary significantly based on location. Research the average costs in the specific area. This can be done by consulting with local contractors, visiting home improvement stores, or checking online resources specific to their region. Relationships with several local contractors can provide insights into current labor rates and material costs. It’s also beneficial to get multiple quotes for a more accurate average.

Understand the Scope of Work

Assess Renovation Needs: The cost per square foot can dramatically differ depending on the type of work required. Cosmetic updates like painting or flooring cost less than structural changes or major system overhauls (plumbing, electrical, HVAC).

Detailed Inspection: A thorough property inspection by a professional can help identify all necessary repairs, which can then be used to estimate costs more accurately.

Leverage Industry Benchmarks

National Averages: While local rates are more accurate, national averages can provide a baseline. Websites like HomeAdvisor or Remodeling Magazine’s Cost vs. Value Report can offer useful data.

Adjust for Specifics: Use these benchmarks as a starting point and adjust for local variations and the property’s specific conditions.

Include Contingency in Estimates

Plan for the Unexpected: It’s common to encounter unforeseen issues during a flip. A contingency budget (often 10-20% of the estimated repair costs) should be included to cover these surprises.

Utilize Software and Online Tools

Estimation Software: Numerous software tools and online calculators are available to estimate renovation costs. These tools can factor in local rates and specific project details and even provide itemized breakdowns.

Flipsquad: Our database is continually updated to deliver the most up-to-date and pertinent information on the housing market and availability. With SARV scores calculated in real-time for each query, our estimates offer exceptional accuracy, providing the data you need to make informed decisions in your home-flipping ventures.

Learning from Experience: You’ll better understand actual costs as you complete more projects. Keeping detailed records of past projects helps in refining future estimates.

Networking: Engaging with other flippers and real estate professionals can provide practical insights and shared experiences about cost estimations.

Monitor Market Changes: Material and labor costs can fluctuate due to market trends, supply chain issues, and economic factors. Regular updates to cost estimates are necessary to stay accurate.

Practical Application with the 70% Rule for House Flipping

This is more than a mere calculation; it’s a comprehensive risk management and investment strategy. By limiting the purchase price to 70% of the ARV, investors inherently cushion themselves against market uncertainties and ensure a built-in profit margin.

Consider this detailed example:

• Estimated ARV of a property: $300,000
• Estimated repair costs: $40,000

Applying the Rule:

Maximum Purchase Price = ($300,000 × 70%) − $40,000 = $170,000

In this example, exceeding the $170,000 threshold would compress the profit margin and amplify the investment risk.

Benefits

• Risk Control: It offers a buffer against market downturns and unanticipated repair costs.
• Profit Assurance: Adherence to the rule can lead to consistent project profit margins.
• Streamlined Evaluation: The rule simplifies the property analysis, facilitating quicker investment decisions.

Limitations for the 70% Rule in House Flipping

The Rule, while valuable, isn’t a one-size-fits-all solution. Various factors can necessitate adjustments:

Market Dynamics: In fast-appreciating markets, the rule might be overly conservative, while in declining markets, it might be too risky. Imagine a property in a rapidly growing urban area where real estate prices are increasing swiftly due to a tech industry boom. 

The ARV of a property might be estimated at $400,000 currently, but given market trends, it’s likely to appreciate significantly in a short period.

Calculation: $400,000 (ARV) × 70% = $280,000 – [Repair Costs] Given the fast appreciation, an investor might justify paying slightly more than the 70% rule suggests, as the ARV is likely to be higher by the time the flip is complete.

Consider a property in an area experiencing an economic downturn, leading to a drop in real estate values. The ARV might be less reliable as the market could further decline when the flip is completed.

Calculation: $300,000 (ARV) × 70% = $210,000 – [Repair Costs]. In this case, it may be prudent to pay less than the rule suggests, possibly around 60-65% of the ARV, to buffer against further market declines.

Experience Level: Beginners in house flipping should consider a large buffer for unforeseen costs. An example would be a beginner flipper who finds a property that is a good deal. The ARV is estimated at $250,000, and repair costs are estimated at $40,000.

Calculation: $250,000 (ARV) × 70% = $175,000 – $40,000 = $135,000 maximum purchase price.

Given their inexperience, which might lead to underestimating repair costs or time to market, consider further reducing the maximum purchase price, possibly buying at around $120,000 to allow a larger buffer if you have little experience.

Property Specifics: Exceptional properties or those in highly sought-after locations may warrant a deviation.

An example would be an investor who spots a property in a prestigious neighborhood known for its high-end homes and excellent amenities. The ARV of the property is estimated at $500,000. However, its prime location and uniqueness (like its historical significance) add more value.

Calculation: $500,000 (ARV) × 70% = $350,000 – [Repair Costs]

Due to its prime location and unique features, the property will likely sell quicker and possibly for a higher price than the estimated ARV. The investor might consider paying more than the rule calculation, perhaps up to 75-80% of the ARV, accounting for these exceptional factors.

The rule is a fundamental guideline in house flipping, providing a balance between risk and reward. It’s a tool for ensuring that investments in distressed properties don’t exceed prudent financial limits while maintaining profitable margins. However, applying it with a deep understanding of the market, the specific property in question, and the broader economic environment is imperative.

Real estate investment, particularly flipping houses, is a sophisticated venture that demands a blend of market savvy, practical renovation experience, and financial wisdom. The 70% rule in house flipping is crucial to this mix, offering a structured approach to evaluating investments. Yet, it’s essential to complement with ongoing market research, adaptation to economic trends, and an openness to learning from each investment experience.