Right now the markets are very tight for buyers in most parts of the country.
Most areas have very few REOs and short sales compared to a few years ago. Good deals to fix and flip are much harder to find for investors. With the tight market I see people ask all the time on the BiggerPockets forum if it’s okay to pay more than 70% of the after repaired value (ARV) minus repairs on fix and flips. My answer is yes; under certain circumstances.
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
What is the 70% rule?
The 70% rule states you should not pay more than 70% of the after repaired value minus the repairs needed. If a house is $150,000 and needed $20,000 in repairs the 70% rule states you should not pay more than $85,000. $150,000 x .70 = $105,000 – $20,000 = $85,000. This is a guideline commonly used by many investors to decide how much to pay on a fix and flip.
I pay more than 70% of ARV all the time
I don’t always follow the rules and I pay more than 70% of ARV on a lot of our fix and flips. We have six in the pipeline right now and here are my calculated ARVs on each one.
You can see we have one great fix and flip at 62% of ARV and the rest are slightly over the 70% rule.
History of my experience with the 70% rule
Before I found BiggerPockets I had never heard of the 70% rule. To calculate how much we paid for flips we would write out the estimated costs and projected ARV (new term to me as well) and hope to have at least a $20,000 profit on houses that would sell for $150,000 or less. We would want more profit for more expensive houses, because of the higher risk and we would have more money tied up.
I didn’t realize it at the time, but we were basically using the 70% rule on our typical flip.
Is the 70% rule a good guideline?
Yes, I think it is an excellent tool for investors to judge fix and flip deals. I still think investors should always list all the estimated costs and calculate their profit as well. The 70% rule can be a good indicator, but not the only tool used to make a decision on a fix and flip.
Costs to consider on fix and flips
1. Repairs (always be conservative)
2. Carrying costs (interest, points)
3. Monthly costs (utilities, hoa, insurance, taxes)
4. Buying costs (back taxes, cash for keys, liens, code violations)
5. Selling costs (commissions, closing costs, transfer fees, title insurance)
6. Unexpected costs (I always add $5,000 to be safe).
I am sure I missed a few, but these are the basic costs we always consider. I take the ARV, subtract these costs, subtract my minimum profit ($20,000) and I get my purchase price. For the example I just used here would be the rough numbers. This is a house bought off the MLS so there will be no buying costs.
-$5,000 carrying costs
-$2,500 monthly costs
-$0,000 buying costs
-$6,000 selling costs
-$5,000 cushion for the unexpected
$111,500 breakeven point
You may notice this method produces a buy price that is higher than the 70% rule even with a $5,000 cushion. If you look at the numbers closely you should be able to figure out why.
How Can I Buy Properties for More Than the 70% Rule?
The number one reason I can buy for more than the 70% rule is I am a Real Estate agent. We bought all of the homes in our pipeline off the MLS, except for 1 which was a public trustee sale. When I bought the houses I got a commission check back for 2.5 to 3 % of the purchase price. When we sell The houses I will save another 3% in commissions, because I can list it myself. Not all of the 5.5 to 6 % is profit as it is taxable income, but that lets me pay more than the 70% rule. You will notice in the figures above I only calculated 3% for the selling commission, when most investors will l have to calculate at least 5.5%. I didn’t even calculate the money I got back for my commissions when we bought the house. I will chalk that up to income taxes for the total commissions I made.
I also have been flipping for over ten years and know the market better than anyone. I can nail down my ARV pretty well and be confident I am not 10% off on prices. Because of that confidence I can go one or two percent higher than the 70% rule even if I wasn’t saving money on the commissions.
The final reason I can pay a little more than the 70% rule is I have great financing lined up with my bank. We can finance 75% of the purchase price at 5.25% right now with 1.5% points. I can’t finance the entire purchase amount like you may be able to with hard or private money, but I have been doing this long enough to build up a bankroll that can pay for down payments and repairs. (I also have a little private money as well at 6%) If you have to pay 15% interest plus 3 points to a hard money lender, your carrying costs are going to double or more.
Huge advantage over other investors
I talk about why being a real estate agent is such a huge advantage in this article here. You can see in this example how much money it saves me. Not only does it save me money, but I can pay more for houses than other investors can, because I save all that money. I believe that is a big reason why I have 6 fix and flips in the pipeline right now.
Thoughts? Share below!
Photo: Ricardo N. Cabral