70% Rule: Does it Apply in Costly Markets

26 Replies

Hello BP community, I live and Sell Homes in San Diego CA. I stumbled upon this property, SOLD for $609,000 needed flooring, paint, kitchen and bathrooms (flipper refinished cabinets) then sold it for $709,000 two months later. Based on the 70% Rule, the investor should only have paid $496,300. After Selling expenses, estimated at 4.5% and Construction/Materials no more then $30K, for a rough estimate of $61,905 (doesn't include taxes). My question is, does that "70% rule" apply in High Acquisition markets? Is 85% ARV too much of a risk? Does that even leave enough spread to make a profit?

Im in Ventura county which is also an elevated housing market. I push the envelope above 70 percent, but never above 80. Obviously you have to go beyond that initial "rule of thumb" and determine rehab and holding costs. Dont forget you give up appx 8 percent on closing costs alone.

It depends. If your fixed costs are 20% of ARV, then going to 85% means you're going to lose money. If your fixed costs are 5% of ARV, then going to 85% means you'll still make 10% of ARV in profit.

Instead of using the 70% rule, why not just calculate a purchase price based off actual numbers and desired profit?

https://www.biggerpockets.com/renewsblog/2010/03/1...

Justin, thanks for your input, I was curious to see if it was used as a hard rule or based on one's own numbers.  J Scott, i'm going to play with my scenario numbers with the/MPP thanks! 

I agree with J Scott. I would never but a property above 80% for a flip, but 70% deals are more difficult to find. Plan on doing your own marketing. If it's coming from a wholesaler probably 75-77% is a good deal dice they are probably making already 5%. Your basically partying the wholesaler for finding you deals. Granted there numbers need to be spot on. My own flips are between 70-77%

@Dulce Beltran No 70% rule in metro areas, I'm seeing 80-83. There are too many people who have excess income and need a tax shelter.

@Leo Lanza Who cares how the acquisition is, as long as you're ok with the profit, doesn't really matter who you buy it from. A friend of mine bought it at 82% all cash, got 50k above asking, ask him if he would rinse and repeat. Price was 600k acq from a wholesaler, he knew the wholesaler was making 30k, he didn't care. He is ok making 100k in 4 months. Yeah yeah, 15-18% is low. But, why not, right?

@Manolo D. Thanks, I'm interested in Flipping and am not there yet, building capital and learning as much as possible. That is what I'm seeing since spread can be huge in our markets, 15-18% is low in percentage and high in actual cash made, averaging $70K per flip in San Diego in "A" neighborhoods. 

@Dulce Beltran I think the flipper had to be very experienced with good teams in place and many efficiencies including his own realtor. I could not do that flip and expect to make any money. The purchase was at 85% ARV. I do not have the teams in place or the efficiencies. My little rehabs take almost 2 months.

So either the flipper was very good or he did not make much money.  I suspect I would lose money if I tried that flip.

However, finding 70% of ARV purchases is difficult and getting more difficult. I am in escrow on a buy and hold in San Diego county that is ~$30K below current value. I suspect the purchase is at ~80% of ARV but I am not flipping it so I do not have to be that precise on expected ARV. Could I flip this purchase and make a profit? I think I would not be making as much of a profit as I would desire but would make a small profit. Part of the issue with this REI is that it is not so thrashed that all upgrades/rehab would return full investment. If it was more thrashed I could possibly purchase for less than 80% ARV but those are difficult to find and purchase.

So if I were flipping I need to purchase for significantly less than 80% ARV to make the type of profit I would desire. If I could find something at 70% ARV that would definitely permit a decent profit. However, for buy n hold instant equity is tough to pass up and 80% of ARV is pretty good. I am happy with the pending purchase.

@Manolo D. Okay, 1. Paying cold cash is different because you don't have financing costs,  but you want to make at least 10% profit or how can you justify the risk. A realtor commission is 6% and they have no money invested. 

@Leo Lanza 1. Precisely, they are their own HML, they pocket the interest, it's not all that different. 10% on a 1M average 3/2 house is 100k, i'll take 50k if I have only 200k invested at any given time. CA realtor is not that much, I've seen some paying couple hundred/thousand for listing it on MLS, then investor takes care of other paperwork. Nowhere in CA will pay 6%, that's 60k for a regular house, just to push paperwork, you kidding?

@Dulce Beltran Yes, but you can't grow 15% of 700k in 4 months on a flip business, he was just lucky that he got 50k over asking. He would have been ok with 50k income on a 700k investment but at 100k, he was extremely excited. 70k per flip is low on a 2M selling (A) and high on a 450k class D.

@Dan Heuschele That's another area of interest as well, Buy and Hold, thank you for the insight, so 80% ARV works in San Diego. Currently helping two clients find properties that will sustain themselves now or cash flow in a year or two as they plan to live in the properties.

@Manolo D. Agreed, definitely depends on the neighborhood supporting those large sums! 

@Dulce Beltran , if in an expensive market it's ok to still pay 85% ARV (or, whatever percentage* you settle on), try to ensure that it INCLUDES its renovation and holding costs. In your quoted example, the investor effectively used a "91% Rule" in order to attain their $61k pre-tax profit. 91%, all-in, might be a perfectly acceptable "Rule" in that town! My 2c...

* BP's "70% Rule" seems to be promoted to: (unlicensed) Wholesalers - who "sell" to Flippers, not Owner-Occupiers!

@Brent Coombs In one of the podcasts with @Sharon Vornholt, she explicitly uses the 70% Rule as a wholesaler, and am curious if it applies best for Wholesaling properties rather then flipping.  Also, I was unaware one needed their license to become a Wholesaler, what are the pros/cons?

@Dulce Beltran Being a wholesaler is a grey area, some states are not that strict when someone is buying and selling a house without a license. Agents argue that if you are buying and selling for a profit, then you are being an agent with no license. Wholesalers argue that they are merely brokering or assigning their interest in buying the property (which they don't have the intention of buying it themselves), they further argue that they are simply looking for a buyer in-behalf of the seller, yet they execute a purchase and sale agreement and "assign" it to someone. This will never fly in CA. I don't think that 70% is a RULE that is a very heavy word, more like 70% suggested buying price, rules in my industry are meant to work 99% of the time. 70% assumes that you are to make 15-20%, and 10% will go to fixed expenses, 5% will go to buffer for "oops" factor, construction delays, selling delays, etc etc. My formula is different. MAO = ARV - 10% ARV - Repair - Profit I want to make (maybe 100% of repair value or 50k whichever is greater).

@Juan Moreno Just running the $$ numbers.  For example:

ARV - PP - Rehab - Fees/Commissions - holding costs = Profit.

For me, the profit has be a decent amount. then I compare it to the amount of cash I put in. cash on cash ROI. If I feel comfortable with it, then I got for it.

Originally posted by @Dulce Beltran :

@Brent Coombs In one of the podcasts with @Sharon Vornholt, she explicitly uses the 70% Rule as a wholesaler, and am curious if it applies best for Wholesaling properties rather then flipping.  Also, I was unaware one needed their license to become a Wholesaler, what are the pros/cons?

 If you PAY the Seller, BEFORE marketing/wholesaling property, then sure, no License necessary to sell YOUR property.

The (il)legality of marketing property you DON'T own, is the topic choking up BP's data storage. You DON'T want to be on the wrong side of RE Regulators who are out there to fining heavily folk who broker RE without a License.

By now, I believe there's been sufficient evidence given to prove that the answer to your thread title is: No.

Good luck...

@Manolo D.  thank you, I'm researching more info on wholesalers and the BRE. I inferred the additional 30% included additional costs and profit and didn't know the break down, thank you! 

@Brent Coombs for my business, i do all the work upfront, ethically, and legally; anything outside of that does not interest me, i enjoy doing things right! i do have my RE license and can broker/market properties when the owner hires me, definitely am researching more information. And yes, I appreciate everyone's response and experience/figures provided, it's helped clarify my follow up questions!! 

BP ROCKS! 

The 70% rule of is not a rule, rather a back of the napkin guideline meant for properties in price ranges below $200k. In fact, you may need to se a 65% rule in some deals where the exit value is below $100k. Point is, the ARV does make a difference in how far you adjust that guideline. The extent of the rehab and market conditions of the subject property (meaning the time it can take to hold) can affect how much you adjust the guideline as well.

I have done deals between 72%& 83% with a few grand slams below 70% all of them with ARVs of $400k or higher dating back almost a decade.

So to answer your question simply, the 70% rule needs to be adjusted based on a number of factors and criteria, it is not a "rule".