The 70% rule is an important guideline for house flippers to follow. It states that the purchase price of a property plus renovation costs should not exceed 70% of the after repair value (ARV) of the home. This rule helps ensure that flippers can make a sufficient profit when they sell the renovated home.
What is the 70% rule exactly?
The 70% rule for house flipping is:
Purchase Price + Renovation Costs ≤ 70% of ARV
Or to put it another way:
Max Offer Price = ARV x 70% – Estimated Renovation Costs
The ARV or after repair value is what the house is expected to sell for once renovated. The 70% rule states that the total costs going into the flip (purchase + renovations) should not exceed 70% of this expected sales price.
Example of the 70% rule
Here is an example to illustrate using the 70% rule:
ARV: $200,000
Purchase Price: $100,000
Renovation Costs: $30,000
$100,000 purchase price + $30,000 renovations = $130,000 total investment
$130,000 total investment ≤ 70% of $200,000 ARV
$130,000 is 65% of $200,000
So in this example, the total costs are less than 70% of ARV, so the deal satisfies the 70% rule.
Why is the 70% rule important?
The 70% rule serves several important purposes for house flippers:
1. Allows for profit margin
By limiting total investment to 70% of ARV, flippers ensure there is room to make a profit. After selling costs like real estate commissions, closing costs, holding costs etc, the 30% cushion allows for a reasonable profit.
2. Accounts for errors in ARV estimate
Estimating ARV is not an exact science. The 70% rule provides a buffer in case the ARV ends up lower than expected. If total costs are kept to only 70% of ARV, there is room for error.
3. Covers unexpected renovation costs
Renovation projects often involve surprises that increase costs. Keeping total costs to 70% of ARV leaves wiggle room for budget overruns.
4. Allows financing if needed
Mortgage lenders want to loan less than ARV. The 70% rule keeps the loan-to-value ratio within acceptable limits for financing.
5. Simplifies analysis
Having a straightforward 70% rule of thumb simplifies deal analysis. Flippers don’t have to run detailed calculations on every deal to know if it works.
What happens if you violate the 70% rule?
Violating the 70% rule by overpaying for a property and/or underestimating renovation costs can get flippers into trouble in several ways:
1. Reduced or negative profit
Exceeding 70% of ARV eats into profit margins. In a worst case scenario, total investment exceeds ARV and the flipper takes a loss.
2. Harder to get financing
Mortgage lenders will be hesitant to finance a deal with total costs exceeding 70% of ARV. Financing may require a larger down payment.
3. Harder to sell
Buyers and real estate agents will be wary of a flip with a small spread between total investment and sales price. This can mean a longer time on the market.
4. Financial strain
Tapping too much capital on a single risky deal can mean flippers don’t have enough cash left for other deals or expenses.
In summary, violating the 70% rule leaves very little room for error and puts unnecessary strain on the flipper’s finances.
When can you exceed the 70% rule?
In certain situations, it may be reasonable to exceed the 70% rule:
For high-end luxury flips
Luxury home flippers sometimes have to pay closer to 80% of ARV to acquire and renovate premier properties. The high sales prices provide cushion.
| Scenario | ARV | Purchase Price | Renovations | Total Costs | Percent of ARV |
|---|---|---|---|---|---|
| Luxury Flip | $2,000,000 | $1,500,000 | $300,000 | $1,800,000 | 90% |
For small cosmetic flips
For flips that just require minor cosmetic renovations, total costs can sometimes approach 80% of ARV.
| Scenario | ARV | Purchase Price | Renovations | Total Costs | Percent of ARV |
|---|---|---|---|---|---|
| Cosmetic Flip | $200,000 | $150,000 | $20,000 | $170,000 | 85% |
When seller financing allows it
If the seller is willing to finance, flippers can sometimes acquire the property with little upfront cash. This flexibility allows exceeding 70% of ARV.
If the market is rapidly appreciating
In a hot market where home values are rising quickly, the 70% rule can be stretched because ARV will be higher by the time the flip is sold.
In general however, the 70% rule should be followed to maximize profit potential and minimize risk.
How to determine ARV
Since the 70% rule is based on ARV, accurately estimating after repair value is crucial. Here are some tips for estimating ARV:
Check recent comps
Research prices of recently sold comparable homes in the neighborhood. Adjust for differences in size, condition, upgrades etc.
Get real estate agent input
Local real estate agents can provide expertise on what pricing is realistic for the area and property type.
Account for renovation boost
Consider how your planned renovations will impact property value compared to comps. Some upgrades add more value than their cost.
Factor in market conditions
If the market is trending up, the ARV will be higher than past comps. If the market is declining, ARV may be lower.
Determining accurate ARV involves analyzing recent sales, appraising home improvements, and understanding the current market. Build in a slight cushion too for best results.
Typical renovation costs
In addition to estimating ARV accurately, house flippers need realistic renovation budgets. Here are typical costs for common renovations:
| Renovation | Typical Cost Range |
|---|---|
| Kitchen | $10,000 – $30,000 |
| Bathroom | $4,000 – $15,000 |
| Flooring | $3,000 – $7,000 |
| Painting | $1,000 – $5,000 |
| Siding | $8,000 – $15,000 |
| Roof | $6,000 – $12,000 |
| Windows | $300 – $700 per window |
| Landscaping | $3,000 – $10,000 |
These costs can vary dramatically based on home size, materials selected, and location. Get multiple contractor bids to hone in on accurate numbers.
How much profit should you aim for?
Experienced flippers look to get 10-20% profit on their investment. With the 70% rule, that means aiming for 10-20% of the ARV as profit. On a $200,000 ARV, profit would be $20,000-$40,000. Anything over 20% profit is considered an exceptionally successful flip.
Of course, the risk involved also determines desired profit level. Quick cosmetic flips generally aim for lower profit margins, while full gut renovations need bigger returns to justify the risk.
Here are general profit guidelines by flip strategy:
| Flip Type | Typical Profit Goal |
|---|---|
| Cosmetic | 10-15% of ARV |
| Minor Renovation | 15-20% of ARV |
| Major Renovation | 20%+ of ARV |
The 70% rule helps flippers reach these profit targets. Optimal profitability requires accurately projecting both ARV and renovation costs.
Strategies for sticking to the 70% rule
Here are some tips for adhering to the 70% rule during your flips:
Leave room for negotiation in offers
Don’t offer the absolute maximum you can afford based on the 70% rule. Leave some wiggle room for back and forth negotiation with the seller.
Get extensive home inspections
Inspections help identify any issues that could increase renovation costs above estimates.
Build contingencies into contractor bids
Ask contractors to pad bids by 10-20% to allow for unexpected problems that crop up mid-project.
Maintain a cost overrun cushion
Even with contingencies, have extra funds available to cover renovation budget overages.
Secure financing early
Getting financing locked in early provides flexibility if you need to increase your purchase offer later.
Careful planning and preparation prevents going over budget and exceeding the 70% rule.
Pros of using the 70% rule
Following the 70% rule has many benefits for house flippers:
More profitable flips
Keeping costs below 70% of ARV ensures sufficient profit margin on deals.
Lower risk flips
The 70% rule minimizes risk by reserving capital as a buffer against errors or surprises.
Prevents overpaying
Basing offer prices on 70% of ARV prevents purchasing properties for more than they are worth.
Streamlines analysis
A simple 70% rule of thumb makes quick deal analysis easy vs. complex calculations.
Allows financing
Following the 70% rule keeps loan-to-value ratios within lender limits.
Better cash flow
More profitable flips mean more cash available to keep pursuing new deals.
Cons of using the 70% rule
The disadvantages of relying on the 70% rule include:
May cause missed opportunities
Rigidly adhering to 70% could mean missing out on some profitable deals that require stretching.
Doesn’t account for all factors
The 70% rule is a basic guideline. Other aspects like financing, market trends also determine success.
ARV and renovation estimates may be off
Inaccurate estimates of ARV and renovation costs undermine the 70% rule.
Can encourage overleveraging
Always borrowing up to 70% of ARV to maximize purchases adds financial risk.
While generally useful, flippers should view the 70% rule as a starting point rather than an absolute mandate.
Key takeaways on the 70% rule
Here are some key points to remember about the 70% house flipping rule:
- Purchase price + renovations should not exceed 70% of ARV
- The 70% rule ensures sufficient profit margin on flips
- Accurate ARV estimates and renovation budgets are critical
- Goal is typically 10-20% profit margin on flips
- Leaving wiggle room in offers and budgets helps adhere to the rule
- Consider the 70% rule a general guideline rather than an absolute requirement
By following the 70% rule, flippers put themselves in a position to maximize returns while minimizing downside risk. But the rule should be applied intelligently rather than blindly to investment property opportunities.
Frequently Asked Questions
Should I always follow the 70% rule?
The 70% rule is a good guideline for most flips, but there can be exceptions. In hot markets or for luxury flips, going above 70% may be reasonable. The rule should be followed in most cases but still allow flexibility based on circumstances.
What if my renovation costs exceed 70% of ARV?
If it becomes clear during the flip that total costs will top 70% of ARV, you may need to re-evaluate the deal. Consider putting in more money to complete renovations, adjusting the scope to reduce costs, or walking away and taking the loss.
Can I still make a profit if I exceed 70% of ARV?
It is possible but difficult to still profit if you go above 70% of ARV. You will need to sell at the absolute top of your expected price range. Any errors in ARV estimate, real estate commissions, or other costs could wipe out profits completely.
What if my ARV estimate is too high?
An ARV estimate that is too optimistic can get flippers into trouble quickly. Not only are actual profits reduced, but the flipper may over-invest due to the inflated ARV. Get multiple opinions on ARV, study recent comps thoroughly, and always build in a margin of error.
Should I follow the 70% rule for my first flip?
The 70% rule is especially important for first-time flippers. It helps minimize risk while you are learning the business. Following it will increase your chances of a successful initial flip.