The 70% Rule for House Flipping
There are many factors that go into a successful fix and flip and investment. House flippers need to do a lot of research and planning to maximize their return on investment (ROI). Nobody ever said house flipping was easy, even if it looks fun and exciting on TV!
Setting the Right Purchase Price
One very important factor of flipping houses is the price you pay to buy your property. Of course, you want to find a good house in a good neighborhood—one that will fetch a nice price once it is fixed up and ready to sell. However, you don’t want to end up overpaying. That will not leave much meat on the bone. If it doesn’t present strong profit potential, the house may not be worth buying as an investment.
So, how do you set a proper home buying budget as a house flipper? Experienced investors may recommend the 70% rule. It is a general rule of thumb to help you avoid overpaying for an investment property. Here’s how it works:
What is the 70% Rule?
This concept states that you should never pay more than 70% of the house’s after-repair value (ARV) minus projected repair/renovation expenses. It is essentially a method to ensure there is enough meat on the bone for acceptable profitability.
How Do I Calculate the 70% Rule?
The 70% rule for real estate investors is actually pretty simple. First, you must project the after-repair value of the property. Do your market research, look at comparable homes in the neighborhood, and estimate the lowest end of what it might sell for once you have made your repairs and/or renovations. Let’s say you are looking at a house that should sell for anywhere from $400,000 to $430,000 after it has been remodeled. You will want to focus on the lowest amount of this price range when doing your 70% calculation. You can’t expect to get top dollar every time, so be conservative in your price estimates and use the base price as your foundation.
In this case, 70% of the lowest ARV ($400,000) would be $280,000.
Next, you want to estimate the total costs of your repairs and renovations. How much will you be spending to get the property to a point where it will fetch that after-repair value? Carefully plan out your renovation and project all the time and costs involved. Again, it’s smart to be conservative here and build in a little cushion. Renovations rarely go exactly as planned, so you have to expect some delays, complications and extra costs along the way.
Like your projected selling price, you may end up with a total renovation expense range. Let’s say this house will cost somewhere between $30,000 and $50,000 to complete the repairs and remodels that you know will make it sell for the highest price possible. Looking at your spending budget is the opposite of looking at your estimated selling price. Here, you will want to look at the higher end of the cost range.
Let’s do some math. 70% of your ARV is $280,000. Now, subtract $50,000 from that amount (projecting for the highest estimated renovation costs). You are left with a total of $230,000. This represents the most you should pay to purchase this investment property.
The Final ROI
In this example, the worst-case scenario will find you buying the house for $230,000 and then spending $50,000 on repairs and renovations ($280,000 total). However, you would be able to sell the property for at least $400,000, leaving a minimum 30% profit of $120,000.
These are just the worst-case scenario numbers above. It pays to be conservative in your estimates, as well as look at the lowest selling price vs. the highest renovation costs. If you buy the house cheaper, your build comes in under budget and/or the house sells for a higher price, that only means more profit potential!
This is a basic overview of the 70% rule for house flipping. For more real estate investment resources and access to exclusive off-market property deals, join the PropertyLark network.