The 70% Rule

18 Replies

The 70% rule of thumb seems like a great way of determining how much to purchase a house for. 

How many people that use the 70% rule actually achieve the 70% rule once the rehab has been done and the house has sold? In other words, how many people actually sell the house for 100/70 times the (purchase price + expenses).

Should the expenses include realtors fees and holding costs?

I believe expenses should include all fees and costs associated with the sale. 

This article about hard money also talks in depth about the 70% rule.

hard money and the 70% rule

From the article, the 70% rule assumes 10% of ARV for soft costs and 20% of ARV for profit. It stands to reason that if you can reduce your soft costs, you could probably go over the 70% rule a little bit. Key ways you could do that are using your own money, or private money at a good rate, or working as your own agent. All of those would greatly improve your soft costs. If you're using hard money and paying an agent, it's probably more important to try to stick with the 70% rule because your soft costs will be higher.

Another good article on 70% rule here.

When doing our flips, we generally are pretty loyal to the 70% rule. This accounting method lets us sleep better at night knowing that we didn't over-pay for that location, and gives us significant cushion incase of a blow up. However on occasion we have been known to go above the 70% rule in the case of a higher end asset class with larger ARV's above the 800K range (Atlanta specific).

@Matt Cramer

 @Bill Hinshaw

 @Charlie Claxton

Great info. Bill's post clears up the question I had about realtor fees and holding costs.

I was more thinking about after the houses have been fixed and resold. Once all the dust has settled and the profit is counted up, is the profit still 20% of sale price? or is it closer to 15 or 10%?

I was just wondering if surprises during rehab tend to result in cost overruns that eat into the profit. So, the 20% profit, if fully financed, usually turns into 15%. I suppose if that happened on a regular basis then you would need to get better at estimating your repair costs.

For my first flip which is currently in progress, my purchase price + repairs is at 77% of ARV and my profit should be at 17% ARV. My return on my money should be 22%.

I'm not paying any interest. If I had a hard money loan, I'm pretty sure I'd be looking at a flop. However, with essentially zero money costs and a favorable market, I think we are going to come out ok. Maybe even a homerun if the market continues to go up in my area, but I'll be happy if we just hit the numbers above.

If someone was able to make 15% of ARV consistently on financed flips, I would think that is pretty dang good. That's 30k on a 200k ARV. If you only had 30k of your own money in that house, that's a 100% return on your money. I'd do that every day if I could.

Im 50/50 on how and when i take the 70% rule into consideration. Honestly, I think its a way for lazy investors to do half of their due diligence and bank on the 70% rule ENTIRELY. When another investor finds an easy way to evaluate multiple asset classes by one simple formula, it creates opportunity for the next. 

I ask investors all the time "would you take on a fix-and-flip that had 90% Seller Financing, 0 interest for 6 months- balloon payment after 12 months, Purchase $150k, rehab $10k (cosmetic update), and ARV $200k, comps avg DOM under 10 days?" Its hard for me to believe any true investor would past this up and if they did either they do not know what they were doing or they arent investors at all.

So the 70% rule definitely has a place in flipping but it is not the ultimate determination of a deal. along side a few other considerations the 70% rule is a great tool, but like all tools they are only valuable when the are used correctly

this doesn't taken into account your cash-on-cash return if leveraging. also, I find this rule to not be very accurate for most people. I'm perfectly content with making $10k. how many employees get bonuses like that?

I have one that is 86% of the ARV when you include my carrying costs, etc. I still stand to make $20k and a 162% cash-on-cash return.

who can argue with that one? :)

At 86% your talking about 4% left without including carrying costs. Your seller costs are 8-10% so after removing those your doing a deal to make 4%? Its so easy to go over budget by 4% that you can easily lose money on 86% ARV. So I guess Im arguing with that one sort of.

The only way Id ever go as high as even 80% as if it failed it would still cash flow with debt to it as a rental.

The 70% rule is a very good way to analyze any flip deal because its based on percentages.  It is however a rule of thumb and you should clearly go into more depth but if its way above that then its not worth looking at.  

What it actually does is gives you 10 percent for seller closing costs 10 percent for holding costs points and fluff and 10 percent for profit not 20 percent for profit.  That last 10 percent gets dwindled down quite a bit.  You can adjust those a little but going under 8 percent for closing costs is not a good idea.  If your the realtor you might consider it but thats just trading investing for working.  You might as well just focus on listing other peoples properties if your going to substitute prophet for labor.

The same goes for using your own money.  You really should be counting your holding costs as if you are using all other peoples money at the normal rate you would get.  I hear this all the time from other investors in my area. When I say I often use hard money they might say something like"I use my own so I can pay more" I shake my head and see someone who is trying to work themselves to financial freedom.  Im not saying you shouldn't use your money in a business that you believe in but to not account for it in your numbers as if it was loaned to you is the same as doing the work yourself but not paying for the labor.  Working for free.   With money you can just loan it out and get those returns without doing the flip so why wouldn't you account for your idle money.  

Heres an example of what I mean.  I just lost about 5000 to 6000 because of Idle money.  In this situation I "verbally" agreed to buy from a wholesaler in Washington.  (Yes Verbal so I know where I went wrong) We agreed on the phone late at night I said Ill take it and would meet to sign whatever worked best for him.  I was going to have a hard time later the next day so I said if needed I can tonight or possible early in the morning , he claimed would have a tough time early but it would be fine even if he had to wait.  (Thought I was building a new relationship here)  So how did I lose money you wonder.

 I  currently have quite a bit of idle money sitting around these days as the deals are fewer between so I recently invested some in another business I own.  That being said I kept enough to pay all cash for at least one house and mix the rest with hard money for a couple more or simply use a mix to do several.  As soon as We agreed to do the deal I emailed my hard money lender to do another  deal Im closing on tomorrow.  I did this instead of using my own money which when used on my own project would be earning me what the hard money lender would be charging.  In this case I get charged 12% and 2 points.  "Thats the money I lost."  I would have paid all cash on the deal I am closing on (I could cancel the loan but I told the lender Id use them and I don't like to go back on it).

Now I still have idle money and am paying points and interest on a deal when I thought Id have more of the money in play and more deals.  Now if I happen to get a good deal right away it helps to ease that loss but it is a little tougher right now so I was pretty bothered by it.  There is more to the story but the point is to show that you should still value the money in a deal even if its yours.

This doesn't mean you shouldn't use your own money or do the work yourself but not accounting for what you would have paid in both situations is creating a job not an investment.  

@Kevin Scott I never thought about it that way before. The lost opportunity of being able to use that money for another investment. I'm a fairly new private lender and I have friends ask me all the time why people borrow money and don't use their own money.  I tell them that it's so that they can keep their own money to do more deals. But I like this way of thinking. Counting for the holding costs even though you are using your own money makes total sense because you could be using that money to make the same type of returns that you get from paying for the money. Thus opportunity lost. I like it. 

@Julian Buick   ya its definitely something to at least think about.  I personally take the approach of separating both sides of any business I am involved in.  Investing is the passive side where you should be evaluating how to use your money and maximizing roi, depending on risk tolerance of course.  The money is working for you.    Then there is the active side where you are working/managing etc.  In this case you should be paying yourself for the work done as if you hiring it out.  Both always have a cost associated with them.   

When someone says they will use their own money or do the physical work themselves to save they really aren't saving they are making an equal trade where there is 0 gain.   That doesn't mean they should or shouldn't.  

 If you have idle money above and beyond reserves use it in the businesses you believe in.  If you like to do the physical work and don't have a normal job do the physical work and hire someone to do the marketing or other parts you don't like. 

Side note your in Kirkland?  Do you attend any rei meetups etc.  in Washington.  What are your favorites

@Kevin Scott the only one I go to is the unofficial BP meetup that @Troy Fisher hosts. It's called Pacific NW Real Estate meetup east side edition. It's a lot of fun. There are also the south end edition and Seattle edition but I haven't been to any of those. 

You're in Tacoma? I just bought a rental down there. 

Hope you don't minde if Ilook up the meetup and nice going on the rental .

Interesting conversation @Julian Buick , the way I explained to the Pellego guys was that 70% is a filter especially in our area. But it is a variable that changes depending upon your overall investing algorithm.  People doing a few flips a year that don't have volume have to have those wider margins for safety and profit.  

Soft Costs:

If you are your own realtor you can shave off 3% which gives you a competitive advantage so you can offer more.  If have a $5mil private money fund behind you looking at 5% returns, you can shave off another 7% and you only need an 80% rule.  

But what if you are a volume guy? And can buy bulk rates at deeper discounts?  Another Competitive Advantage! What if you are swinging your own hammers?  Are your own contractor and can cut out some of that cost?

Rules of thumbs are great filters to learn and quickly process deals, but without experience and knowledge it's as useful as something that isn't very useful.

Also, In Regards to the Meetup!  Yah! The one in Lakewood is on Monday @Kevin Scott  http://www.meetup.com/PacificNWRealEstate/events/2...

With us returning to the Eastside on April 8th: http://www.meetup.com/PacificNWRealEstate/events/2...

@Troy Fisher  Pellego just crunched the numbers on ~13,000 historical flips in the greater Seattle area and found the median purchase price to final resale is ~64%. Note that this number includes some sort of rehab; I suspect most investors are not hitting 70% minus rehab. With this in mind, ~34% of flips have a purchase price of 50% or less of the final resale price. 

Updated over 2 years ago

Sorry, those numbers are how much higher ARV is than purchase price. As a percentage of ARV, the median purchase price is ~61% and the average is ~59%. Less than a quarter of purchase prices are 50% or less of the ARV.

woo! Data! Is that bought/resold with < 6 months or 12 months? Including/excluding foreclosires?

@Troy Fisher Our flip data set is built with a 2-12 month turn around and includes properties purchased at foreclosure auctions. The flipped sale must also sell for at least 25% more money and must be sold as a standard MLS listing. From this data set, the median flip takes 181 days and the average flip takes 192 days (speaking of hold time...).

Historical data, which includes what timeframe? 1900-current? Last 5 years?

Our data set goes back to 1999. With this in mind, we have more data for the more recent years than we have for the older years, so the data leans towards present day.

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