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How To NOT Make Less Than Minimum Wage on Your House Flips

by Michael LaCava on February 16, 2014 · 27 comments

  
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I had just pulled out my driveway to head to one of our new properties in Freetown, Massachusetts.

Today was “tear down day” and  I was pumped!

It had been a while since I did a tear down and I was really looking forward to seeing the excavator rip it all to shreds.

I felt like a kid on Christmas morning…totally excited to see it happen and shoot a few videos in the process.

Just then, my 2009 Chevy pickup started making funny noises.

I’m no auto mechanic, but I knew these “noises” were not just the result of sub freezing temperatures we’ve been getting here in Winter-bound Wareham, Mass these days.

Even though I knew I could probably make it to Freetown, I did the right thing and took it to my local Sullivan Tire to have them look at it.

After throwing it up on the lift they said my “ball joints” had shot. I had no idea what these are and I had even less of an idea of what it was going to cost me. I asked sheepishly the price and after the tech did a few calculations on his computer, he said it would be $798.

Yikes!

I couldn’t exactly “shop around” for a better deal as I was pressed for time, so I told them to do it.

That’s when I thought to myself how I wished that calculating how much to pay for  truck repair was as easy as how to pay for a house flip…

How Much to Pay For a Flip Using The 70% Rule

How much to pay for a property…always a tough one to figure out.

Tough that is…unless you have strict rules.

Determining the comps in the area is a great start which we’ve talked about here a few times before.

From there, you heavily rely on your ARV and then from there, you need to know what the cost of repairs are going to be.

Cost of repairs is very important as well and when you do your walk-through with your general contractor, you’ll get that number.

You now have your ARV and your cost of repairs, the two most important numbers there are in house flipping. Number 1 being ARV and Number 2 being cost of repairs.

Once we know those two numbers, then we can apply our formula. It’s called The 70% Formula or otherwise known as The 70% Rule. It’s a very common formula, thousands of other investors use it besides just me, largely because it just works so well.

The 70% Rule Makes You Money

Some investors don’t quite understand how the 70% Rule works – they just know to do it, but they don’t really understand why.

But for you, you do want to understand how it works so you know how to control it and use it to your advantage to hep you make more money.

Sometimes we use a percentage different from 70%, because we have to adjust up or maybe even down based upon the property. But for the most part, when you’re getting started you want to use the 70% Rule as is – right at 70%.

So let’s see it in action, then explain after why it works so well.

A 70% Rule Example on How Much to Pay For a Flip

1. Get Your ARV

So let’s say we’re looking at buying a property with an ARV of $200,000.

To get to that number, our real estate agent has done a complete Comprehensive Market Analysis (CMA) and everything in the neighborhood is selling for $210,000, $215,000, $205,000 – all basically in that range. So based on our CMA, we’ve determined that $200,000 is a really good realistic, somewhat conservative price point.

So here’s how the 70% Rule works. All you want to do is take that $200,000 and multiply it times 0.7 – which will give you $140,000.

Now if the house is in perfect, saleable condition as is, our Maximum Allowable Offer (MAO) would be $140,000.

Great for you if that’s the case!

But the reality is as a house flipper, you don’t buy houses in perfect condition. So the chances are that you’re going to have to do some renovation.

After all, distressed properties that look like this are what you want to ideally go after.

These are properties with failed septic system, the ones that have mold, the ones that are full of trash, the dregs of the property world.

You want the properties that everyone wants to run out of the soon as they walked into it. These are the ideal types of properties for you. We have a few saying around the offices about these gems:

Mold is Gold

Smells Like Money

No EXCUSES

Well…the last one has nothing to do with these properties, but we still say it all the time anyway!

The reason why you target these kinds of properties is simple: you’re typically not competing against the retail consumer.

I digress…back to the 70% Rule…

2. Get Your Cost of Repairs

Now let’s say for the sake of argument the cost of repairs is $40,000.

To get to this number, we had our contractor come in, look at everything – including the plumbing, the roofing, the siding, what have you, and he feels pretty confident that property is going to cost $40,000 to repair.

3. Get Your MAO

The next part of the formula is when we then subtract that $40,000 from the $140,000 which gets you to $100,000.

Now we’re looking at a maximum allowed offer (or MAO) of $100,000 on this property.

So you go and offer $100,000…

Hold up there partner…not so fast!

The last thing you want to do is immediately offer your MAO. This is a common new real estate investor mistake because when you put in your maximum allowed offer amount, you don’t leave any room for negotiating.

And when that happens, you’re now stuck.

Remember that this number is your maximum number to pay, so always start lower.

WARNING! WARNING! On ARV

Danger Will Robinson!

Yes, the 70% Rule works awesome – no doubt, but bear in mind that the formula is only as good as the starting number. Meaning that the ARV has to be extremely accurate to begin with.

Let me explain.

Let’s say you have a brand-new real estate broker and she’s very excited to get your business and she gives you an ARV of $215,000. You are psyched. You can already envision all the cool stuff you’re gonna load up on with your hefty profits…

However, she’s overly ambitious and the ARV is way too high. This impractical number now affects every other number downstream.

In this case, we take the $215,000 and multiply that by 70% – we’re now at $150,500. So instead of the $100,000 and the $140,000, we’re now at $150,500.

Although that other ARV number is only 7 or 8% more than the $200,000, these mistakes start to add up on your bottom line…for the worse.

So now we actually buy the property at $110,000. Then lets say it takes longer than you thought it was going to take to sell.

You might be into it for six, seven or let’s say eight in this scenario. This is eight months and your soft costs like interest, maintenance and upkeep and at eight months, they really add up.

In the meantime, your repairs end up costing you $50,000 instead of the $40,000 you projected.

To make matters worse, you go to sell and the real estate agent (the one who told you it would sell for $215,000, by the way) comes back and says you need to sell it for $200,000.

You’re now stuck…over budget, under ARV and into it two months longer than you expected.

The nightmare is not over….

Suddenly, the offers start coming in and they’re not even close to the $200,000. They’re coming in at $190,000, $194,000 and a few below that. So with tail between legs, you settle for an ARV of $195,000. 

In this scenario, you end up making less than minimum wage on this flip…despite eight months of hard work.

The “Less Than Minimum Wage” Numbers

Lets look at the numbers:

  • ARV = $195,000
  • MAO = $110,000
  • COR = $50,000
  • Soft Costs =  $26,000
  • Your Net = $9,000

Now lets face facts, making $9,000 isn’t too bad. But if it took you eight months to do it, when you factor that all out over eight months…its like making $6.39 and hour for all your hard work.

The minimum wage in my state is $11, so that LESS than minimum wage!

Calculation22 work days/month x 8 months x 8 hours/day = 1,408 hours / $9,000 = $6.39/hour = really sucky pay for you

I certainly don’t want to be making less than minimum wage on my flips….

And that’s why these numbers, and I can’t stress it enough, are so critical. And more importantly, its vitally important that you stick to them.

The 70% Rule Unplugged

I like stuff stripped down, like the Unplugged versions of my favorite songs like this one here. Epic…

So lets look at why the 70% Rule works so well in this section.

One of the biggest questions I always get on the 70% Rule is “what is the other 30%, Mike?” Its pretty simple, here’s the breakdown:

  • 10% is your soft costs – like finance charges, brokers commissions, upkeep, maintenance, snow removal, etc.
  • 20% is YOUR PROFIT

So on a $200,000 ARV flip, you should be able to project a $40,000 profit if all else is equal. If you are off on any part, then what suffers is your profit, like in our example above.

And if you stick to all those rules, you will NOT make less than minimum wage…you’ll make far more and probably want to do it over and over and over and over again…making maximum wage all the way.

 

If you’ve made it this far, please leave a comment below! What do you think? Please leave a comment and share your questions — or ask me anything you’d like about flipping houses!

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{ 27 comments… read them below or add one }

Sonia & Paul Spangenberg February 16, 2014 at 8:39 am

Wow, awesome version of “Simple Man”. This is an emotional song for me being the mother of two adult sons, one living and one no longer (15 yrs ago). Happens to also be one of the favorite songs of my living son and the singer sounds a lot like the one who is no longer living! This is the first time a bigger pockets blog made me cry!!! It’s okay because it reminds me how much I love my boys. Sorry for the digress!
But… we’re brand spankin new to REI and have just put in our first offer on a potential rehab. I had done all the calculations with several methods and also used the 70% rule. I recently read a blog that talked about rarely needing to adjust the 70 % a bit for local markets. http://www.biggerpockets.com/renewsblog/2014/02/14/70-rule-bible/
I don’t feel experienced enough to experiment with that yet. But I will say that your description and breakdown of the rule is very helpful way for the newbie to be able to understand the importance of such a rule. Its a short sale and my bid was lower than the already approved short sale price. It appears the short sale approval price was not getting offers for several months, so I threw in my lower offer per 70 % rule. For some reason we are still in consideration after I raised my offer to my MAO when I learned from my agent that the other offer was being favored. I will not go up any further. All this said, I know that I may not get the deal but I will go from this, not defeated, but knowing it just wasn’t the deal for me if I don’t get it! Your less than minimum wage explanation is a great affirmation that I have done the right thing, and will help me to have an appropriate reaction whatever the result. Thanks, Sonia and Paul

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Michael February 17, 2014 at 4:01 pm

HI Sonia & Paul – thanks for sharing your feelings & I can’t ever imagine what you have been through. Congratulations for taking action and in a smart way. Keep working that deal and ask questions on your offer. On a short sale they usually will only negotiate one offer at a time so ask if your offer is the one one they are negotiating with the bank.

All the best & would love to hear when you get it!

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Sharon Vornholt February 16, 2014 at 11:56 am

Great post Mike-

Learning to make offers is a process, and almost all newbies want to “tweak” the numbers to make them work. Heck – even experienced investors do that but it is always a mistake. Once you take the emotion out of this business and look at it as a “numbers game” you will be much more successful. And, you will be able to walk away from marginal deals.

BTW – sorry about your truck.

Sharon

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Sonia Spangenberg February 16, 2014 at 12:09 pm

Truck?

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Michael February 17, 2014 at 4:03 pm

Thanks Sharon. So true. We are finding we have to adjust on some of the higher value homes & base it more on the net margin when we can’t hit the 70% but certainly not for the newbies!

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IJ February 16, 2014 at 1:58 pm

Great article Michael and thanks very much. I see it much more clearer now. I am a newbie and have many questions and here are some pressing ones:
1. What is the seller laughs at and ignores your 70% ARV offer? Do you just work away and look for another?
2. Since I do not have a flip team yet, would you say it is a good move to use FHA 203K and the banks recommended contractors to start off on my first flip?
3. Why is it assumed that the 70% rule is a fair offer on a property since the seller may have paid much more for that property initially?

Thanks in advance for your insights.
IJ

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IJ February 16, 2014 at 2:00 pm

Great article Michael and thanks very much. I see it much more clearer now. I am a newbie and have many questions and here are some pressing ones:
1. What if the seller laughs at and ignores your 70% ARV offer? Do you just work away and look for another?
2. Since I do not have a flip team yet, would you say it is a good move to use FHA 203K (the renovation loan) and the banks recommended contractors to start off on my first flip?
3. Why is it assumed that the 70% rule is a fair offer on a property since the seller may have paid much more for that property initially?

Thanks in advance for your insights.
IJ

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Michael February 17, 2014 at 4:13 pm

Hi IJ.

1- Oh well. If they laugh move on but explain to them why?. Some will get it & other’s won’t. I have had many say no way & in the end it is yes way. Negotiate the deal.
2- I believe FHA 203K is for only people moving into the house. Not for investors.
3- It is the math percentage of what we have to buy at to make a profit. What other’s have paid has no relevance. If that was the case we wouldn’t be buying many houses. This is why we mostly buy properties that are in distressed because it wont’ work if they are good shape which makes more sense to what you are saying.

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Sherry Williams February 16, 2014 at 2:38 pm

This was just what I needed to hear today. My husband and I just looked at a HUD home today that is now open for investors to bid on. I just got done figuring out my MOA by using the 70% rule and also manually subtracting all of my costs from the ARV. My offer is so low that I’m sure it won’t get excepted, which is what always happens to me. I make offers, but have never had one excepted yet. I was almost considering upping my bid so that we have a better chance (which I know better). Then I read your article. Thank you!!! I will submit my bid and see what happens.
Sherry

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Michael February 17, 2014 at 4:14 pm

Good luck Sherry.

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Kevin Perk February 17, 2014 at 12:42 am

Mike,

Nice post. Great explanation of the 70% rule. Don’t try and force the numbers. Use the rule and stick with it.

Good job on keeping things simple man. :)

Kevin

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Michael February 17, 2014 at 4:14 pm

Thanks Kevin. Love that song.

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Danny February 17, 2014 at 8:50 am

Mike,

I felt your pain even before finishing the article, in regards to that $800 cost to fix ball joints…that is painfull, they should not cost that much even the Labor.

I like Sharon’s point of “taking the emotion out” of the business, I think thats when things really start to make sense, and also getting realtor who understands your business and knows what they are doing.

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Michael February 17, 2014 at 4:16 pm

Hey Danny,

Yes Sharron’s comments on emotion is right on. As far as the truck repairs I just suck it up and move on. Cost of running a business.

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Adrian Tilley February 17, 2014 at 10:18 am

Good article. To be fair, you’re not really working 8 months at 40 hours/week. It would probably be more like 4 weeks full time (160 hours) plus 5 or 10 hours per month after that (10 x 8 = 80) for a total of 240 hours, or (9,000/240 = $37.50 per hour). A lot better, but I don’t think it undermines the main point of the article, which is to be careful with your numbers.

Adrian

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Michael February 17, 2014 at 4:20 pm

Yes I agree with You Adrian & quite honestly those hours will be different for everyone and how much they are on or off the job. Whether they work or they invest full time…..

For Me I don’t see much of my renovation now until they are done. So I may only have a few hours in a specific deal because we have so many going on at on time.

I was hoping someone was going to bring that up so thanks for paying attention!

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Ralph February 18, 2014 at 5:50 am

Adrian – I think Mikes point was that you don’t want to work for such a small sum over an 8 month job. Even when you factor in less hours, its still too little pay for the time, effort and most importantly, the mental energy and anguish as a part of it.

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IJ February 17, 2014 at 5:34 pm

Michael,
Thank you very much. I have just learned a great deal from you.
IJ

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Winona Benson February 17, 2014 at 8:06 pm

Hello, Hi, Hello Mr. Michael. What an awesome article and outstanding breakdown, breakup, crunch it all and sum it up on the 70% rule that will eventually or at some point will rule and reign over most ineffective hybrid rules. I’m a newbie and I am nowhere near to applying this method, but I will not dismiss it. I will be back to take notes. My interest in this field is to first learn as much as I can. I’m waiting to start my carpentry courses because I would like to rehab, flip or rent, but I want to learn how to be cost effective in what ever decision I make. I know you have to be careful not get yourself in the ditch of a money pit and God forbid yet you have to learn and that’s what its all about.

Well, it’s been good and I really enjoyed this informative article. For all that have read it, they know that you have put us in the mix and after the mixing is done; I guess we will be ready to enter into the oven-coming out pure as gold, Got to be tried by the fire:)

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Michael February 23, 2014 at 11:10 am

thanks Winona. Good luck with your carpentry course to gain the knowledge on the construction side of this business.

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Josh February 18, 2014 at 10:34 am

This 70% rule would scare me. In California, property prices are a lot higher. Simi Valley the average home is $500k, Westlake Village it’s $700k, and Thousand Oaks $600k. In these areas, to discount a property $180,000 is extremely material to seller. Everyone knows what their neighbors property sold at. Further, to rely on an arbitrary safety discount of 30% will yield you very few properties, and is not a good way to sustain your business. My advice for more expensive properties, use a conservative ARV, project rehab costs conservatively to the nearest dollar, and add a misc. expense line item, and assign an 8-10% return with the hope that your conservative estimate was pessimistic, and that extra size of land, newer property, or horse zoned property premium that the comps didn’t have bumped you to the 5-6 figure returns.

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Michael February 23, 2014 at 11:15 am

Hey Josh – agreed in the area’s you mentioned that the 70% rule will not win you many properties especially if you are relying on MLS listings. You must try other marketing methods to attract deals and if you still can’t find any deals then you have a decision to make. Buy at 80% rule and you better know what your doing because the slightest hick up and you could be in trouble. I don’t suggest this to newbies at all but for someone more experienced maybe like yourself this might work fine for you or them. the other option is to buy in other markets that support deals in the 70% rule.
Thanks for your comments

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Maurice February 19, 2014 at 3:41 pm

Michael,

I’m a newbie to flipping. thanks for all the knowledge & simple but straight forward talk. I will definitely be better equipped b/c of this article.

Thanks again,

Maurice

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Michael February 23, 2014 at 11:16 am

Your welcome Maurice. Good luck

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Josh Randall February 23, 2014 at 9:07 pm

Thanks for the great info. My brother and I are in the process of buying our first flip and we know the ARV and rehab costs are critical. For first timers would you say it’s absolutely necessary to walk thru with a GC prior to making an offer? And would you recommend paying for an appraisal during the contingency period?

Thanks,
Josh

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Junior S April 7, 2014 at 11:45 pm

Great article, Michael! i’m originally a wholesaler, but preparing for my first flip and I love your articles. Very realistic and thought out great/

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Michael April 10, 2014 at 3:36 pm

thanks Junior. Where are you doing your first flip. Tell me about it. Congratulations and hope you do very well on it.

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