Learn how this simple calculation can help you ensure a significant profit margin when flipping a house.
By Savannah Sher | Updated Sep 2, 2022 9:33 AM
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Welcome to Bob Vila’s Guide to House Flipping, a series dedicated to showing you the best places for house flipping, crucial steps for selecting a property, must-do upgrades and repairs, and surprising ways to reduce your costs to get the most from your house flipping sales. Here you’ll find fresh insights mixed with Bob’s tried-and-true advice, our vetted shopping guides, and the inside track to the right professionals to get your flip to the finish line.
In the world of house flipping, there is a common adage that many in the business live by when it comes to determining their potential profit margins. Known as the 70 percent rule, this guideline can play an important role in the success or failure of your flip. Many real estate investors use the 70 percent rule to determine if a house is worth the time and money it would take to flip. The basic principle is that a flipper should never buy a home for more than 70 percent of its after-repair value (ARV) while also factoring in the cost of renovations.
In this article, we’ll explain how the 70 percent rule works, offer tips for determining a home’s ARV, and outline exceptions to this popular guideline.
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What is the 70 percent rule in house flipping?
How does the 70 percent rule work in practice? In order to use it, you’ll have to do some simple calculations. The equation is: “After-repair value (ARV) ✕ .70 − Estimated repair costs = Maximum buying price.
So, for example, if you estimate that a home’s ARV is $500,000, you would multiply that amount by .70, resulting in a price of $350,000. You would then subtract the estimated price of renovations. If you predict that the house requires $50,000 in renovations, then your maximum purchase price would be $300,000. While this isn’t a hard and fast rule, it does provide an easy way to estimate your potential profit on a flip.
Tips for Projecting After Repair Value
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The most important factor when using the 70 percent rule is to determine the home’s ARV accurately. Overestimating a home’s ARV could result in a reduction in profits. In order to establish a realistic ARV, there are a few steps you can take.
- Determine the home’s “as is” value. The process of projecting ARV starts with estimating what the house is worth in its current condition. The as-is value for a home can be determined by getting estimates from local real estate agents or by comparing the home to other similar homes in the area that have recently sold. Consider having the home appraised in its current condition in order to establish an accurate “as is” value.
- Research comps in the area. Before considering a flip, you should be well-educated on your area’s current real estate market. Websites like Zillow and Trulia are great for doing research on what houses in your area are selling for. In order to estimate a home’s projected ARV, look at the sale prices of comparable homes that have been renovated in order to be move-in ready.
- Estimate the cost of repairs. Enlist the help of a contractor who can provide an expert opinion on what it would take to bring the home to its full potential. A contractor can tell you what materials they would use, the cost of those materials, and the approximate amount of time that it will take to complete the renovations.
Costs That Aren’t Included in the 70 Percent Rule
There are a number of additional costs to take into consideration when buying a home that are not factored in as part of the 70 percent rule. Some of the most significant costs are:
- Closing costs: These typically equal between 3 and 5 percent of the total cost of the home and include things like title insurance and attorney’s fees.
- Realtor fees: Typically 6 percent of the home’s sales price, these fees come into play when the house is listed for sale.
- HOA/condo fees: Some properties require additional monthly fees for management and maintenance.
- Transfer and conveyance fees: Taxes that must be paid when a property is transferred between owners.
- Financing costs: The costs incurred by using outside funding.
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Final Thoughts
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While the 70 percent rule is a useful way to estimate potential profits, it isn’t the only factor to consider when investing in a house to flip. Sticking to this guideline may be impossible in certain hot markets, where flippers may be forced to offer up to 85 percent of a home’s ARV in order to have their offer accepted. Always be sure to do market research before investing in a home to flip.
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The 70 percent rule in house flipping is a fundamental guideline relied upon by real estate investors to gauge the potential profitability of a property. This principle suggests not purchasing a house for more than 70 percent of its estimated after-repair value (ARV), accounting for renovation costs. It's a straightforward calculation: ARV multiplied by 0.70, minus estimated repair expenses, yields the maximum purchase price.
Determining the ARV accurately is pivotal. One starts by evaluating the property's current worth ("as is" value) through real estate agents' estimates, recent comparable sales, or professional appraisals. Researching comparable homes in the area that have been renovated offers insights into the projected ARV. Collaborating with contractors helps assess repair costs—materials, labor, and time required.
However, the 70 percent rule doesn't cover certain expenses like closing costs (around 3-5% of the home's total cost), realtor fees (typically 6% of the sales price), HOA/condo fees, transfer taxes, and financing expenses.
Adhering strictly to this guideline might not always be feasible, especially in competitive markets where offers might reach up to 85 percent of a home's ARV to secure a purchase. Therefore, comprehensive market research remains crucial before investing in a property for flipping.
Regarding the broader concepts involved:
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House Flipping: Buying properties with the intent to renovate or improve and sell them at a higher price within a short period for profit.
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After-Repair Value (ARV): Estimated worth of a property after necessary repairs or renovations.
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Market Research: Essential analysis of the local real estate market, including comparable sales, trends, and demands.
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Cost Estimation: Assessing renovation costs accurately, often with the help of contractors, including material expenses, labor, and timeframes.
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Additional Costs: Beyond the 70 percent rule, various expenses such as closing costs, realtor fees, HOA/condo fees, transfer taxes, and financing expenses should be factored into the overall investment.
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Flexibility in Guidelines: Acknowledging that strict adherence to guidelines like the 70 percent rule might not always be feasible, especially in competitive or fluctuating markets.
Understanding these concepts is vital for successful house flipping, ensuring informed decisions, accurate estimations, and realistic profit margins.
