Investor · San Antonio, TX · Member since 2013 · 27 posts · 3 votes
I currently do not have this home under contract. However, I'm just an email away from getting it under contract. Here's the numbers
ARV = $575K
Repairs = $100K
Selling price after my fee = $325K
It doesn't quite meet the 70% rule. However, there is still money to be made. So my question is to rehabbers; as a new wholesaler, does the 70% rule have to be met on all deals, even if it's on a higher end home like this one? Or, is it a case by case basis. A follow up question is, will hard money lenders lend you all cash (selling price + repairs) if it adds up to more than 70% of the ARV? I'm curious for possible future rehabs of my own. Your help is appreciated.
I never paid attention to the %, the bottom line dollars are what is important. If you want to do the work involved for the time involved to make the money involved, then do it regardless of a %.
It is much more important to have accurate estimates than to adhere to this VERY GENERAL rule.
Generally speaking, it is a case-by-case basis.The 70% rule is over-generalized and out dated. It's a nice rule of thumb(I suppose) but if you consider the organic nature of this market, ever-increasing competition and varying investment strategy options--the 70% rule is going to end up hurting you in the long run. According to your example above, you are making plenty of money and if you follow that rule, you are going to miss out on a $100,000+ profit because some Real Estate Guru wanted to sell a book. With regard to Hard Money Lenders, if their standard loan amount is 70%, you will most likely come out of pocket with the rest of the cash. However, there are many lenders that will lend on varying degrees of investments and just might lend you more, if there is money to be had. With that being said, you may be crossing into predatory lending if they aren't sticking to their own underwriting guidelines. Anyway, I hope you don't miss out on $100,000 because a of a ratio. Happy Investing!
Here's why the 70% rule doesn't work and shouldn't work for this property.
The 70% rule is a simple calculation that attempts to estimate the purchase, holding, and selling costs and your potential profit on a deal. Because the 70% rule is based off your ARV, you will get a proportional result any time you use this calc. The formula works fine for me around an ARV of $250k but once you start estimating costs for a property with a low or high ARV (i.e., $100k or $500k), you'll get incorrect results. Here's an example that shows how much profit I would actually make if I purchased a property based on the 70% rule:
ARV Repairs Purchase Actual Profit
$100,000 $30,000 $40,000 $16,900
$250,000 $80,000 $95,000 $54,000
$500,000 $100,000 $250,000 $116,200
As you can see, the deal would be very thin at the $100k ARV mark and if you incur any overages on your rehab costs, it would be very easy to lose money on the deal. On the other hand, if you try using the 70% rule at the $500k ARV mark, you'll likely find that you are being out bid and won't get many deals.
My advice is to understand all your costs and base your rehab analysis off those costs.
And for what it's worth, that sounds like a great deal. Based on my analysis (and estimating for some numbers as I don't know the tax rate, property insurance rate, etc where this property is) I would estimate a potential profit of $111,700.
More of a guideline than anything. Its incredibly hard to find 70% deals in my market, out of the last 10 or so, maybe 2 were strict 70% deals, and the rest made us 18-30k each. It just depends on your threshold and risk tolerance.
The seller is an investor from another state. He's been holding it vacant since Feb 2013. I wrote the contract up for the his price, and he responded saying that he wants a $10K Earnest Money Deposit, with a $6K Option period fee for "holding costs" for the month I'll be wholesaling it.
My question...
Is it common for a wholesaler to put down a $10K EMD, with a $6K Option period fee, if I'm not even the guy who's going to rehab the property? I told him respectfully, "I conceded to your price. At your price, I would expect you to concede to my terms." My terms being a much smaller EMD and OP fee.
If those numbers are right and he can get you this property, I would jump all over it...I would just make sure you get a legit contract and have an attorney/title company hold the deposit. I would also try to have a back up plan to buy the place if you can't wholesale it because those numbers would work well for me and I would jump through hoops to make it happen, just don't be willing to do something stupid
@Max Garcia Jr , I don't use the 70% rule either as a wholesaler and even when I rehabbed houses. The 70% rule does not work in HOT markets and it does not work in declining markets as well. It does not work with high end homes like in your wholesale deal.
Your wholesale deal is a GOOD DEAL. The renovator can make $90K profit on it (based on my calculation).
Now, regarding what the seller is asking for: a $10K EMD + the $6K option fee... I don't understand though what you mean by the $6K option fee for the month you're wholesaling it.
As a private lender, I would do this deal but the rehabber will have to put some money in repairs.
Is it common for a wholesaler to put down a $10K EMD, with a $6K Option period fee, if I'm not even the guy who's going to rehab the property? I told him respectfully, "I conceded to your price. At your price, I would expect you to concede to my terms." My terms being a much smaller EMD and OP fee.
What do you think?
I don't know that that 6k thing is, and combined with the $10k EMD feels like a flag to me. Make sure this guy seems legit - that he's not scammin' you.
My apologies. He wanted a $10K EMD, where $6K of which was an option period fee. If I decide to cancel the contract during the due diligence phase, he would keep $6K, and I'd only receive $4K back.
However, I declined his terms stating that if I have to concede to non-negotiable price, he'd have to concede to my non-negotiable terms. My terms were a $50 open escrow, and a $25 option period fee.
He accepted! Now I'm going to have a reputable realtor to do a CMA on it, so I can make sure I'm selling a good product.
Thanks for the input guys.
This sounds like a great deal! The mere mention of the 70% rule drives me insane. There are several comments above explaining many of the issues, so I'll spare you the rant. Congratulations on getting the contract accepted and good luck finding a buyer!!
Congratulations Max. You got some good advice here and you followed it. It hope it works out well.
Funny I find criticism of the 70% rule (and other guidlines) drives me insane.
The 70% rule is a rule of Thumb, or Guideline. It is a totally valid guideline. Most new investors don't have a CLUE how much in hidden costs there are in real estate. Rules of thumb like the 70% rule keep a lot of newbies out of trouble.
My apologies. He wanted a $10K EMD, where $6K of which was an option period fee. If I decide to cancel the contract during the due diligence phase, he would keep $6K, and I'd only receive $4K back.
However, I declined his terms stating that if I have to concede to non-negotiable price, he'd have to concede to my non-negotiable terms. My terms were a $50 open escrow, and a $25 option period fee. He accepted! Now I'm going to have a reputable realtor to do a CMA on it, so I can make sure I'm selling a good product.
Thanks for the input guys.
- you were able to get the seller to go from demanding a $10k escrow to a $50 escrow???
Also regarding large downpayments (imo, over $1k) We'll often have our end buyer (rehabber) put the money down soon after we get under contract with the seller. In other words immediately after we get a signed contract from the seller, we assign to our end buyer and collect the downpayment with the understanding that we have no liability towards it and that the seller's attorney (we use attorneys up here) will be holding it in escrow.
Two things usually help in order to pull this off:
1) All parties need to know that you're wholesaling (not mandatory but it helps).
2) A good relationship with a buyer ready and waiting in the wings. We've often gone in to see a property for the first time with our buyers. That way we know right away what our buyers are willing to pay and therefore what we can offer the seller.
Alright @Ned Carey is calling me out :) -- So here goes...
My contention is the 70% rule is both absurd and dangerous. I cannot fathom how or why anyone would enter a deal without a clue as to their expected profit.
As an example, consider a simple $100K property needing $20K in repairs. The MAO = .7*100-20 = $50K. That's easy enough, but what's the profit???
Let's consider a few scenarios...
Unless otherwise noted, I put 20% down and have $2000 on the front end to cover appraisal, bank fees, attorney fees, title insurance and recording costs. I have $1000 on the back end for the attorney and home warranty. Carrying costs include utilities, property tax, and insurance and are a function of time.
1) I have a FT job, great credit and can get a renovation loan at 6%, no points. I expect to have the property for 6 months and sell using the same agent who helped me buy the property. She agreed to list it for 5%.
This yields a very nice profit of $18625 and even if I slip a few months, I can net $16825.
2) I am self-employed or need to close quick, so I use a hard money lender who lends at 15% with 5 points. In this case, I'll also use a real estate agent to sell, but she is charging 6% to list the property. If I can turn it in 6 months, I can make a respectable $12925. At 9 months, this drops to $9775 though.
3) I have high net worth and am using cash. My spouse is an agent, so I only pay the buyer's agent 3%. At 6 months, I have $22425 and even after 9 it is $21525.
In all of the scenarios, I make money. This is good. However, is the second scenario really a good idea? I'd better be really tight on my estimates and hope I don't run into any unforeseen issues. On the other hand, what if I lose the 3rd deal because I was too conservative. Offering $55 would net me $15+ for a very limited amount of work while walking away yields nothing.
Just for fun, here's 1 more
4) In this case the same house needs $50K in work and the purchase price is $20. I have an equity partner who is going to from the entire purchase and I am going to do the labor. After hundreds of hours of work, we sell in 6 months for a profit of $19425. My portion is $9712.50 which works out to ~$20 / hour.
Now, I do accept that assertion that "Most new investors don't have a CLUE how much in hidden costs there are in real estate." (Sorry, I don't know how to properly attribute quotes). But, I don't accept that arming them with a rule, guideline, or whatever that will yield a range of $9775-$22425 on the same investment is helpful. Instead, the solution should be to teach them what those costs are so that they can make informed decisions.
Max, congrats on locking down a solid deal, if the numbers bear out as you stated you shouldn't have much trouble finding a buyer.
I agree with @Ned Carey the 70% rule is a guideline, a quick estimate to use when running through possible deals. You definitely want to perform a more detailed analysis before moving forward.
Instead, the solution should be to teach them what those costs are so that they can make informed decisions.
Agree 100%. I think if you look at the threads that explain the 70% rule they do say why the rule exists and help explain the numbers.
Lets take the original poster's example.
ARV $575 - repairs $100K. Gee I can offer $425K and make $50K. A lot of people think like that. I would rather someone doesn't know if they are going to make $9K or $25K vs being guaranteed of loosing money.
@Ibrahim Hughes Yes, I did talk to down $10K, haha. I know it would've been acceptable for me put down $1K or so, but he wasn't working with me on price, so I figured I'd make it easy on me on the EMD side.
I think the 70% formula is good for making quick decisions but if you are going to be into a property for 200k-300k- 400k, you better make sure you know your expenses, the cost of money, taxes, repairs, real estate commissions, attorney fees, etc. Then once you know your expenses and your ARV, its pretty simple to determine the profit on a deal and then decide if it worth the time, effort, and risk to move forward. With this deal that is being proposed, it seems to me that the profit should be somewhere in the 75k-100k range so who cares what rules or guidelines there may be. Flipping houses isn't always a science, its about making $, having freedom, and enjoying what you do. (i'm sure there's more to it but those are my 3)