The 70% of after repair value “rule” is a formula commonly referred to by real estate investors and used as a barometer when purchasing distressed real estate for a profit. The formula calculates the maximum amount to pay for a given property once two key factors, namely the after repair value (ARV) and estimated repair costs (ERC), are considered.
The 70% rule states real estate investors shouldn’t pay more than 70% of the ARV minus the repairs needed. If a house is $150,000 and needs $20,000 in repairs, the 70% rule states not more than $85,000 should be paid. The math looks like this:
$150,000 (ARV) x .70 (ARV percentage) = $105,000
$105,000 – $20,000 (ERC) = $85,000 (buying price)
This formula is commonly used by many house flipping investors to decide how much to pay on a fix and flip.
Start analyzing today
A good investment begins with a solid plan built upon solid math. Quickly and efficiently analyze a potential real estate investment using BiggerPockets’ investment calculators. We’re here to help you maximize your profit while lowering your risk—no matter your strategy.
For this formula to work correctly, it is critical the numbers for both the ARV and ERC are accurate and conservative.
The problem with this “rule” is that many interpret it literally. There is quite a bit of misinformation surrounding this rule, and the goal of this blog post is to dispel false information and educate individuals on how to be more competitive in their local marketplace.
It is critical to realize the 70% “rule” is not a “one size fits all” model that can be applied universally to all situations, markets, or exit strategies. In fact, it is not really a rule at all, but rather a guideline—especially in today’s hot housing market, when investors may need to more carefully examine their investments and calculate the numbers to make more attractive offers.
Investors who try to uniformly apply this 70% rule will get fewer offers accepted and miss out on deals because their offers will be less competitive. Being in tune with the market is also key and allows investors to make more competitive, fairer offers that have a higher chance of being accepted.
The 70% rule in theory
The formula itself is rather simple. Once the ARV and ERC are calculated, the numbers have to be plugged in. For this hypothetical example, let’s say a house has an ARV of $100,000 and needs $20,000 in rehab. The last variable to figure out then is what discount to buy at. In this case, we’ll use the traditional 70% rule, so .7 is plugged in.
- Formula: (ARV * 0.7) – rehab
- Example: ($100,000 * 0.7) = $50,000
Why is this “rule” critical?
This “rule” is critical because the ARV and rehab are used in conjunction to calculate the formula. If either of these numbers is inaccurate, there’s the potential to operate on less-than-desirable margins. If the wrong price is calculated, profit margins can quickly diminish or be wiped out completely.
ARV and rehab should always be fixed numbers based on the investment exit strategy; however, the ARV percentage amount minus repairs should be variable. Furthermore, this rule may be completely disregarded as investors become more creative in real estate investing.
For instance, if investors intend to buy and make a long-term hold play, betting on appreciation, they may very well be able to afford to pay more. If this is the situation, investors may be able to buy at 101% ARV if the financing is favorable and the area is desirable. The point is that exit strategy matters.
Is the 70% rule a good guideline?
The 70% rule can be a good indicator—but not the only tool—used to make a decision on a fix and flip. As with anything in real estate investing, investors should always list all the estimated costs and calculate their profit as well.
Costs to consider on fix-and-flips
- Repairs (always be conservative)
- Carrying costs (interest, points)
- Monthly costs (utilities, HOA, insurance, taxes)
- Buying costs (back taxes, cash for keys, liens, code violations)
- Selling costs (commissions, closing costs, transfer fees, title insurance)
- Unexpected costs (add $5,000 to be safe)
These are the basic costs investors should always consider. Then take the ARV, subtract these costs, subtract the minimum profit ($20,000), and it equals what the purchase price should be. If a house was bought off the MLS with no buying costs, these would be the rough numbers:
|Cushion for the unexpected||($5,000)|
This method produces a buy price that is higher than the 70% rule even with a $5,000 cushion.
Housing inventory price point
The 70% rule can adjust depending on the price point of the housing inventory. For instance, if lower-end housing is purchased in Texas with an ARV of $70,000 to $90,000, you may be able to negotiate a deeper discount—say 65%. The best way to get in tune with the local market is to review what recent cash sales have been in the same subdivision as the subject property. For rehab properties, it will show what margins everyone else is operating on. If wholesaling is the exit strategy, this will show how much of a discount is needed to buy.
Major market area
All real estate is local, and major market areas influence the formula. The formula will need to be adjusted based on the market it is in. For instance, in California, the 70% figure could go as high as 80% or 85%. In Dallas/Fort Worth, Texas, where housing is more affordable, 70-78% should serve well. Even more important are the hyper-local factors based on the subject property itself. The ARV percentage will fluctuate from zip code to zip code, subdivision to subdivision, even within the same major market area.
This rule will fluctuate based on the exit strategy as well. For instance, landlords will typically be able to pay more than someone who intends to flip the house. Why? The rehabber will have a higher level of finish out, thus their repair costs will be higher, plus they need to factor in Realtor commissions and other expenses. In contrast, a landlord will be able to pay more because their strategy is completely different, often trying to gain short-term cash flow and long-term appreciation. For example, landlords in northern Texas are commonly buying at 76-80% ARV for their rentals.
Other investors may prefer a different formula; for instance calculating offers based on what they want to earn on the project. For example, if the investors want to rehab a house and net at least $18,000 after accounting for factors such as holding costs, closings costs, realtor commissions, etc., there are models that are a viable alternative to the 70% “rule.”
When can properties be bought for more than 70%?
The number one reason a property can be bought for more than the 70% rule is when a real estate agent is also the investor. When agents buy houses they get a commission check back for 2.5-3% of the purchase price. When they sell they save another 3% in commissions because they can list it themselves. Not all of the 5.5-6% percent is profit, as it is taxable income, but that lets an agent pay more than the 70% rule would indicate.
It also comes with experience. Investors that have been flipping for ten years or more know the market better than anyone. They can nail down the ARV pretty well and be confident that they are not 10% off on prices. Because of that confidence they can even go 1-2% higher than the 70% rule.
The final reason an investor can pay a little more than the 70% rule is that they have great financing lined up with their bank. They can probably finance 75% of the purchase price at 5.25% right now with 1.5% points. They might not be able to finance the entire purchase amount like other investors that have hard or private money, but they have been doing it long enough to build up a bankroll that can pay for down payments and repairs. Take note, if the rate is 15% interest plus three points from hard money lenders, the carrying costs will be double or more for a property.
The 70% rule is more of a guideline, not a hard and fast rule. The percentage of ARV minus repairs will vary based on local markets, exit strategy, and housing type. It all needs to be taken into consideration when calculating an offer. If investors make sure to keep in tune with the local marketplace and apply the 70% formula as a guideline, instead of a blanket rule, it will make their offers more competitive and their real estate investments more lucrative.
More on deal analysis from BiggerPockets
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.