Question with the 70% rule when fix and flipping.
Does the 70 Percent rule apply to homes with an ARV of 700K+? the higher the price of the home the higher the gap you pay with the 70% rule is. I noticed doing the 70% rule on much pricier homes the offers are extremely low, so my question is, is this formula effective with much pricier homes? just because the offers are extremely low using this formula on pricier homes i wonder if this approach is effective.
No. These rules are guides. If you’re walking around and smell poop you generally look on the bottom of your shoe. One then the other. If nothing is there you don’t just say, “Well, there must not be any poop.” You smelled it. You know it’s there, somewhere.
If you have a 700k ARV property, you can offer anything you want, but I bet you still smell a deal even if it doesn't meet your 70% rule.
Follow your nose and the actual numbers.
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Of course, using 70% will work on a $700k house, @Joseph Arellano. So will 50% or 60%. It’s not a rule but a rule of thumb. It’s a guide. Something you can use for quickly screening deals. Your offers will be so low however, you’ll never buy a property. For homes greater than about $250k in Los Angeles (which is now all of them!!) we use 75%**. This is still challenging, but achievable.
This rule of thumb says if you add the purchase price and rehab estimate together, the total should not be more than 75% of the ARV (i.e., pay no more 75% of the ARV minus rehab costs). It assumes you are using a hard/private money loan and paying an agent to sell the house. In this case, you will earn a profit of around 10% to 15% of the ARV. This is a fair profit in our view. For both our safety and that of our borrowers, we won't make a loan unless the property meets this. Lots of people on this board hate this approach and advocate deciding on the profit you want to make, estimating all your expenses, and backing your offer out from all of that. It won't matter.
We always perform both calculations, including estimating all expenses with our spreadsheet, and the results are always the same. If you want to earn 10 to 15% of the ARV, and can estimate all your expenses, it will work out that you'll end up paying about 75% of the ARV minus rehab costs.
On a $700k ARV home, a fair profit would be in the $75k+ ballpark, in our view. If you try for more, your offer will be so low you never get a property. If you're ok with less, and the market drops, or you get a fair but lower offer than $700k, you could lose money. Don't do that and don't get desperate. You are not immune to losing money.
Fair warning, once you hit 85% of ARV minus rehab costs, you will break even if you're lucky. Run the detailed numbers and you'll see. Stick with 75% of ARV minus rehab costs, and/or do the detailed calculations to confirm, and you should be safe.
** Because some expenses only go up a small amount as ARV increases, they take a bigger bite out of lower dollar homes. Thus, you can't pay more than about 70% of the ARV minus rehab costs when the ARV is much less than about $250k. That's why 70% is used in most of the country. Sorry for the journey into wonkiness.
