When you’re first learning how to flip houses, most grizzled real estate veterans will tell you how important it is for you to know “the numbers”.
One things for sure, if you don’t know your numbers…your house flipping career will be short…and excruciatingly painful.
The cool thing is that in the flipping houses niche, you don’t have to understand complex mathematical formulas, have a PhD in astrophysics or possess the intelligence level to unravel the human genome.
Thank God because I can’t do any of those things…
All you need to know is just a little fifth-grade math…as well as have a whole lot of desire.
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
Fifth-Grade Math and the 70% Rule
When it comes to the math component of most house flips, there are some common rules and formulas that you really should understand inside and out before you get into this business.
And best of all, any fifth grader can do it…
For example, here is a complex mathematical formula to test you on:
200 x 0.7 = y
y = ?
Have I lost you yet?
If you answered 140, then congratulations! You have the necessary math skills to be a house flipping superstar.
In doing the extremely complicated mathematical formula above, without even knowing it you have tapped into one of the most important house flipping formula of all.
If you stick to this formula, I guarantee you it will save you thousands and dollars in mistakes in your house flipping career…
And it will make you a ton of money as well.
The Most Important Formula When Flipping Houses
The math we did above was what we refer to as “The 70% Rule”.
Where it came from…I have no idea. But all I know is that IT WORKS.
Although it can’t be exactly applied in every single market, its extremely important to stick by this rule when you are doing your house flipping math.
So as soon as you determine your ARV, (the after repair value of a home or property), the very next step is to use the 70 percent rule to figure out what you need to buy a property for in order to turn a profit.
The accuracy of the 70% rule also depends on your level of experience in gauging the after repair value of a house. This is largely dependent on getting an accurate after repair value to begin with. This number is what you have gotten from your real estate agent or other people on your house flipping team.
As with most things in life, the more experience you have flipping houses and using the rule, the more accurate your estimates will become.
So let’s do an example…
The 70% Rule In Action
You’ve been looking long and hard for your first house flip deal, and you finally come upon a house that according to your real estate agent, if it were fixed up comparable to the neighborhood, would sell for $200,000.
On top of that, there are several comps in the area in the past six months that give you confidence that $200,000 is a fair and reasonable price.
This is where we start our fifth grade math.
1. Take the $200,000 and multiply it by 70% (or by 0.7 on your calculator, for you math whizzes like me):
70% rule: $200,000 x .70 = $140,000
2. Take your $140,000 and now deduct your repair costs. In this case, let’s say that your rehab expenses are $40,000 according to your contractor. Then subtract the $40,000 from the $140,000. This will then give you the maximum price you should pay for the property:
Repair costs = $40,000
70% rule = $140,000
$140,000 – $40,000 = $100,000
Maximum purchase price = $100,000
Pretty simple stuff.
The question is, can you actually get the house $100,000?
That may be a blog post for another day, but let’s say that you can.
So you take the plunge and buy it!
Why the 70% Rule Is So Important
In its simplest form, the 70% rule helps to insure you against taking unnecessary risks and keeping your house flip buying very disciplined.
Even the worst-case scenario, the 70% rule will help to ensure that you do turn a profit or at the least break even.
As simple as it may be, when you’re first learning how to flip real estate, this is a rule you should stick by to keep yourself out of trouble as well as lock in maximum profits.
It also keeps you from fudging your numbers (or “eraser math” as we call it) in order to get the deal done.
The seventy percent rule can save you a lot of dough and prevent you from creating a bad deal….but only if you stick to it on each and every deal.
House Flipping in Expensive Markets: Exceptions to the 70% Rule
As with all rules, there are always exceptions. And as each real estate market is different, the 70% rule needs to be adjusted depending on your market conditions.
I often times use $200,000 as my benchmark for after repair value because that’s what is typical in my market.
I happened to flip lower price ranged starter homes and I found this market to be very lucrative.
We’ll occasionally flip houses in higher price ranges (and are doing more of those now as a matter fact).
But for the most part, I stick to what I really know in the mid-range to lower-priced mark it is where I feel most comfortable right had the most success.
But your market might be different.
If that’s the case, then you may need to adjust the 70% rule to suit your needs.
As a general rule, here are the exceptions to the 70% rule:
- Higher-priced markets: The higher the price a property, the more flexibility you have on the upside for the 70% rule. In these cases over $200,000 ARV, you may consider to be “higher-priced”. In these cases, you may want to go to 80% or even 90%.
- Lower-priced markets: The lower the price of a property, the more flexibility you have on the downside for the 70% rule. In these cases, any house flip under $200,000 ARV you may want to consider to be “lower-priced”. In these cases, you may want to go to 55 or even 60%.
Whatever your market, the most important thing is that you adhere to the rule as best as you can. This may result in you turning down some deals. If you’re first starting out, this is actually a good thing.
I can tell you this though…this one simple rule has kept me out of more bad deals that I can even care to remember!
What do you think? If you made it this far, please leave me a comment below! I’d love to hear about what you think of “The 70% Rule” or questions about anything at all relating to real estate!
Photo: Bart Everson