70% Rule-Please explain?

17 Replies

I understand the math to the 70% rule in house flipping. (Conservative Market value after repairs X.70 - repairs). What I don't understand is where this 30% magically disappears to. I know that there will be closing costs, some utilities during flip, some interest during flip depending on financing, and some closing costs-but does that really come close to 30%? My brother and I are currently rehabbing a house and will likely flip it vs hold it. Here is our situation:

ARV $110,000

Purchase Price       ($58,000)

Projected Repairs   ($15,000)

Profit before soft   $37,000

Our deal appears to be a home run before considering the soft costs. How is it possible that 30% of the ARV gets eaten up by these? Here is the 70% rule math and you see a completely different picture

ARV $110,000

70%          $77,000

Repairs     (15,000)

Max Price  $62,000 (we paid 58k)

In short I am having a hard time seeing us paying more than $8,000 in soft costs, yet this 70% guideline builds in $33,000 of soft cost (30%xARC). Why am I so far off? What am I missing?

Your purchase price, added to the cost of renovations and holding, should not be more than 70% of the sales price. The remaining 30% is supposed to be your profit.

8% sales costs, 3% purchase costs eliminate 11% right off the bat.  Utilities, insurance,carrying costs, loan costs, incidentals are going to run a few percent. So thats going to leave somewhere in the range of 15-18% which is the profit.

However, at least in my market, the 70% rule is a thing of the past.   That number is going to need to be higher today to compete with all the cash floating around in my market.

Originally posted by @Kyle Galloway :

@Russell Brazil-Thanks for that answer. Can you detail your 8% sales costs and 3% purchase costs? Is this a good estimate for realtor and title company fees at closings I assume? I assume sales costs are higher because the seller typically bears the burden of paying both realtors?

Thats my quick estimate of closing costs on a transaction. Buy side...loan costs, transfer taxes, recordation taxes, survey, title insurance, etc. Sell side, agent fees, transfer taxes, recordation taxes, closing help.

Some areas closing costs may be higher or lower than that. PA for instance I think has transfer taxes alone at over 4% before other fees.  Also depends on the price point of the property....really cheap properties are going to have much higher closing costs as a percentage of the purchase price, and more expensive properties lower percentage due to fixed costs like closing fee, survey, etc.

I think your profit after soft costs (why are they soft, they will amount to something quite huge) will be in the neighborhood of ~$18-20k. This factors in purchase cost, sell costs, holding costs, and fluctuations on the repair costs. But kudos to you if you can make that number higher.

I generally think the 70% rule in useless, to me it’s about the spread between what I can buy for and sell for. For example if I buy a house for 70k and sell it for 100k I’m almost certainly losing money because repair costs are basically fixed. Also 15k Reno seems really cheap a carpet and paint rehab alone is 20-25k.

@Kyle Galloway
So my profit is built in to the 30%

I don't know if you meant the entire 30% is your profit but if you did that is absolutely wrong. 

The 30% is you soft costs and your profit combined. About 15-20% of every deal goes to soft costs like buying costs, holding costs and selling costs. What is left is your profit.

The 70% tool is a valuable tool for pre-screening a deal. It is a very crude tool for a final analysis. 

30% is your profit. And most HM lenders will lend 70% ARV. In a perfect world you would be under that a bit because we all know things happen and costs go up once you start tearing into things.

Originally posted by @Jack Seiden :

I generally think the 70% rule in useless, to me it’s about the spread between what I can buy for and sell for. For example if I buy a house for 70k and sell it for 100k I’m almost certainly losing money because repair costs are basically fixed. Also 15k Reno seems really cheap a carpet and paint rehab alone is 20-25k.

if it's a 100k home and carpet/paint cost you >20k...you sir have the wrong contractors. 

 

Originally posted by @Charles Whitaker :
Originally posted by @Jack Seiden:

I generally think the 70% rule in useless, to me it’s about the spread between what I can buy for and sell for. For example if I buy a house for 70k and sell it for 100k I’m almost certainly losing money because repair costs are basically fixed. Also 15k Reno seems really cheap a carpet and paint rehab alone is 20-25k.

if it's a 100k home and carpet/paint cost you >20k...you sir have the wrong contractors. 

To be fair it was a 3k sf house with very bright paint colors that required multiple coat's but the 1st guy didnt even give me a bid becuase it was too small of a job and the 2nd guy was 14k plus 5k for carpet for lowes theres 20k right there.

 

 

@Jack Seiden

That is a crazy huge house for just $100k. In any case, an interior paint job of such a huge magnitude, in my area of course, would be closer to $6k.

I recently quoted someone a paint job and replace flooring (laminate) $8k in a 1400sqft house. Location plays a huge role in costs.

If you sell the property for $110k you will probably net $98 to $100, and if you buy it for $58 it will be more like $61 with closing costs. You will also have interest and utilities and property tax and it might take longer than you think to sell it. You will probably net $15-$18 k after interest, Utils and prop taxes. Then you have to pay income and self employment tax which will take 30-50% depending on your tax bracket. You you are doing a lot of work and taking a lot of risk for $7-$10k.

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