The 70% Rule: How and When does it change?

Question

The standard rule for investors is to buy 70 percent of the ARV, but I've heard that inventory affects this percentage. For example, low inventory in the market might justify closer to 80%, high inventory could mean something more like 50-60%. Is this true, and are the other variable that could change that 70% to something else? What's the best way to determine the proper percentage. I'm a wholesaler and the information is pertinent for me to make offers to my buyers.

Jon Holdman · Answer

Great explanation @Jeff S.  The "70% rule" is just math.  It does make some assumptions:

• Purchase plus rehab is 70% of the ARV
• ARV is the actual price you'll sell for
• You're using hard money with a mid teen rate and several points
• You'll hold about six months
• Your rehab estimate is accurate

If you can change any of those assumptions (e.g., you have your own cash) you can make an appropriate adjustment.  For any specific deal you should build your own analysis using your actual numbers.

As the ARV gets higher, you may be willing to take a smaller profit and still have a nice payday.  The danger is that one, and often all, of these things go wrong:

• Your selling price ends up lower than your ARV estimate
• Your rehab costs more than expected
• You end up holding longer than expected.

These factors all take percentage points off your profit.  So, if you're flipping an expensive house and say "I'm willing to take only a 5% of ARV profit" because that's still a nice profit you can easily slip into a loss.  If you're expecting a 5% profit and your ARV is off by 5% then bye bye any profit.

Jeff S. · Answer

"The standard rule for investors is to buy 70 percent of the ARV …"

No, @Drew Byrd .  The standard rule-of-thumb is to pay no more than 70% of ARV minus the repair costs. The remaining 30% will go all other expenses and will leave around 10 to 12% of the ARV in profit. It applies to flips only and assumes a hard money loan, realistic rehab costs, and that you will be paying an agent for at least one side of the close.

The best way to confirm this and learn, is to prepare a proper P&L by estimating all the costs associated with the flip. If you've done this enough you'll see that this rule-of-thumb works.

I'll add that for deals greater than about a $250k ARV, you can push this rule-of-thumb to 75% and still earn about a 10 to 12% profit.

"If I'm buying a million dollar ARV property as a flip, 75-80% could be possibly."

For a 250k ARV on up, at 80% you'll earn about 5% of the ARV in profit. At 85% you'll be lucky to break even. It's linear. Behind the rehab costs, HML expenses are typically the second greatest costs. If you pay cash, you can push the numbers a little and pay a bit more, but not much more. Rules-of-thumb are good for quick screening. Always run the numbers in detail.

Obviously, if you're wholesaling, you have to pay less to leave some meat on the bones for your buyer.

"… I've heard that inventory affects this percentage. For example, low inventory in the market might justify closer to 80%, high inventory could mean something more like 50-60%."

No. Nowhere on a P&L will you see a category for market inventory.   Inventory affects supply and demand. It dictates how easy or hard it is to find profitable properties as well as the purchase price. Just because it's difficult to find profitable flips, does not mean anyone should overpay. Never forget that the market sets the price and it doesn't care that you or your buyers make money or not.

Jeff S.

Jeff S. · Answer

I can't tell you how many people I know here in L.A. that started out happy to make (a very fair) $50k or $60k on a $450k ARV flip and then decided that since it's now hard to find these, began doing million dollar rehabs with the same expectation.

The problem is that $50k is such a relatively small percentage of a million dollars that it's easily eaten by a reasonable counteroffer, a modest swing in the rehab costs, or a small shift in the market, so "bye bye any profit."

Alternately, if I were still doing lower dollar out-of-state flips, I couldn’t imagine working my brains out to make $12k on a $100k ARV property and would expect a substantially greater discount to the ARV minus repairs.

Dollars are what you put in the bank, but the percent profit represents your risk. You always have to consider both and take heed compromising one for the other.

Jeff S.

The 70% Rule: How and When does it change?

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