Risk Mitigation using the rule of 70
Why is the rule of 70 so important when flipping houses?
The rule of 70 is a common term used among many real estate investors when flipping houses. The rule of 70 is a way to determine what price to pay for a fix and flip to make money.
What is the rule of 70 when applied to fix and flipping houses?
The rule of 70 states that an investor should pay 70 percent of the ARV (After Repair Value) of a property minus the repairs needed. The ARV is the after repaired value and is what a home is worth after it is fully repaired.
If a home’s ARV is $150,000 and it needs $25,000 in repairs, then the rule of 70 states an investor should pay $80,000 for the home. $150,000 x 70% = 105,000 – $25,000 = $80,000. Buying a house for $80,000 that will be worth $150,000 may seem like an awesome deal, but you have to remember all the costs involved in a fix and flip.
Do I use the rule of 70 when flipping houses?
I rarely use the rule of 70 when deciding on a fix and flip. I like to write out all the numbers and decide on a deal after seeing my profit potential. On the above deal I would write all my costs and see if the profit potential was worth the risk. Occasionally I will use the rule of 70 to see how my numbers match up and I am usually very close to what the rule of 70 estimates.
How close would my purchase price be compared to the rule of 70?
$150,000 is the value of the home after the repairs and $25,000 in repairs are needed. I always add at least $5,000 in unknown costs to my known costs on a fix and flip. Selling the house would cost me a 3% commission plus title insurance and other closing fees; approximately $6,500. I will have insurance, utilities, and lawn maintenance while owning the house; I estimate those costs at $2,500. My financing costs will be about $3,500 with my financing terms and loan costs. My selling costs are going to be lower than most people, because I am a real estate agent and do not have to pay a listing agent.
As you can see when I subtract all my costs I have a break-even point of $107,500. I usually want at least a $25,000 profit on my low-end fix and flips (under $125,000 purchase price). If I figure in a $25,000 profit, I should buy the property for $82,500. An investor who is not a real estate agent would be right at that $80,000 number or even a little under it, because they would have to pay another 3% commission on the sales price.
How accurate is the rule of 70 when flipping?
As you can see the rule of 70 was extremely close to what I would pay based on my own calculations. If I can get houses cheaper that is great, but difficult in this market. For beginner investors I think the rule of 70 is a great way to get an idea of what to pay for a flip. You have to make sure your repair estimates are accurate for the rule to work.
In states with an appreciating market, should you pay more than what the rule of 70 states?
Many investors try to stretch the rule of 70 or whatever rule they use when the market is appreciating and it is tougher to find deals. I think this is a huge mistake, because no one knows if the markets will continue to increase, stay stable or even decrease. Most flippers got into trouble during the housing crisis, because they assumed the markets would always go up and they didn’t have to get as good of a deal. Even in an increasing market you should stick to your rules and guidelines, because it is better to have fewer deals that make money than a lot of deals that lose money.
Conclusion
The rule of 70 is one of the real estate investing rules that I think is a great tool for investors. The rule gives a pretty accurate price for investors to pay for fix and flips given the repairs and ARV are accurate.
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