Southern California 70% rule

3 Replies

Hi all. I’ve learned about the 70% rule when purchasing a property to rehab from multiple sources. This was going to be the rule of thumb that I used when doing a quick analysis of a deal. While trying to expand my contact list of buyers, sellers, etc, I have come across a few wholesalers who have properties they are trying to sell to investors. The price they are currently offering the properties would mean that an investor would be purchasing at between 80%-85% of ARV (assuming their figures on repair costs and comps are accurate). On the one hand, I know they say that all wholesalers are not created equal and that you have to weed the good ones out from the ones who don’t really know what they are doing. But on the other hand, I have read somewhere else that it is not out of the norm for investors in Southern California to pay in the 80% range due to lack of deals and fierce competition. I would like to ask any investors in the area if they try and stick to the 70% rule, or if they find themselves paying more than they would like to. Is 80%-85% par for the course in our area when it comes to buying from wholesalers? Appreciate any feedback. Thanks all.

There isn't fierce competition. What we have here is a large pool of subpar investors who were spoiled for 5 years by the flood of foreclosure related properties. So while a few investors honed their craft, many, many more just became junkies and now their supply line has dried up. They are experiencing the post party blues - Withdrawl. This phase of the investing cycle I like to refer to as the culling of the heard. Many, many investors will start dropping out of the business and the few who know what they are doing will continue to run their profitable operations. I've been having the best year of my 10+ year career this year.

Thanks Aaron. That is interesting to know.

This questioned has been asked over and over here and usually out of frustration. This is a related link: http://www.biggerpockets.com/forums/311/topics/86585-70-rule-in-this-market.

We only loan on flips in the LA/North OC area and we keep pretty good records. Here are some real world southern California numbers that might help...

Historically, our average borrower has paid 61% of ARV and repairs totaled 11% of ARV for total project costs averaging 72%. We frequently loan to 75% but rarely any higher and only to those with whom we have a long and trusting relationship. Skilled rehabbers know not to pay more than this anyway, so we're rarely presented with such properties. My point here is that these deals still exist and in reasonable quantities.

We tend to make about 5% of the ARV in interest and points. Sometimes more and sometimes less, but 5% is an average. By assuming closing costs and taxes total around 10%, our average borrower nets about 15% of ARV. Some are brokers and can double end a close so they make a bit more.

With each loan we also do detailed calculations using estimates for taxes, title, utilities, our finance fees, sales commissions, etc., and the results are consistent. You can start buy assuming a profit of 15% of ARV and backing out what you should pay. The conclusion will always be the same; if you pay no more than 75% of ARV minus repairs, you'll make a fair profit with room for the usual errors. Run the numbers yourself, change the amount paid, and you'll answer your own question. If you don't know how to do this, then learn. How else will you prepare a rehab budget? You can't run a business around rules of thumb.

To add, don't think that you can make it up by doing higher dollar deals (i.e. >$1m) looking only at the dollars. The percentages still work except the holding costs can kill you. You'll also see much more variation in ARV and in the actual offers. Receiving an offer $100k less on a $500k property is unreasonable. Receiving one on a $1.25M home could be fair. It might also be all your profit and then some.

On the other hand, if you think you're Superman, or are foolishly willing to make less, or believe somehow that "This time it's different," you will lose money. This is a rule of thumb that works.

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