WARNING: Break These House Flipping Rules at Your Own Risk

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We real estate investors — we are such rebels, aren’t we?

We all seem to want to break the rules. I think we’re all guilty of it at times. I know I am.

But every time I break the rules, it ends up hurting me really badly. Breaking the rules may seem like a great idea at first, but when you break the rules of house flipping and real estate investing, you are really just hurting yourself.

There are tons of examples of breaking the rules, including not adhering to the 70% Rule, using “eraser math” on your ARV and MAOs or maybe dealing with a partner or a team member in a way that goes against your morals.

The hardest one to get over is the last one listed above. Whatever you do, I recommend not breaking those rules ever. But the other rules, especially the 70% Rule, can be broken in very special circumstances.

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Breaking the House Flipping Rules

I’ve recently had a ton of questions from readers of this blog and my own blog on how to flip houses when the 70% Rule may not apply to their market. It may not apply exactly — but it does still apply.

There are many markets in the country that are more expensive than the one that I operate my house flipping business in. Massachusetts by and large is a fairly expensive place to live, but the sub-market where I operate is relatively affordable by comparison to the rest of the Massachusetts real estate market.

I’m well aware of the fact that Wareham, Massachusetts is really not in the same league as Orange County, California with regard to price. However, I have flipped many houses outside of my market and have been very successful doing it using the same principles that I use in my primary market. These are markets that are a little bit pricier and although the 70% Rule does not apply exactly, it still does apply.

As you may recall, the 70% Rule is a benchmark we use to determine how to do our house flipping math.

How to Flip Houses Using the 70% Rule Review

As you may recall, the 70% Rule keeps you out of trouble when you’re flipping houses. It also prevents you from doing “eraser math” when you’re evaluating how to flip houses. I see lots of different ways to evaluate a property, but the 70% Rule is the rule that I’ve always stuck with because although it does not exactly apply in every circumstance, it is an excellent benchmark to use to keep you honest and ensure a good profit on the property.

So, for example, you’ve determined that the after repair value of a certain house is $200,000.

There are several comps in the area in the past six months that indicate that $200,000 is a fair price. These recent sales give you a good benchmark to begin your math.

1. You take the $200,000 and multiply it by 70%, which equals $140,000:

ARV = $200,000

70% Rule: $200,000 x .70 = $140,000

2. Deduct your repair costs from that $140,000. Your rehab expenses will be $40,000, according to your contractor.

Now, using the 70% Rule, subtract the $40,000 from the $140,000:

Repair costs = $40,000

70% Rule = $140,000

The maximum price you want to pay for this house is $100,000:

Maximum purchase price = $100,000

However, there’s a bit more to it…

This formula is extremely effective at keeping you out of trouble, especially when you are first starting to invest in real estate or to flip houses. But as with any “rule,” there are always going to be exceptions…

Before You Break the Rules…Do this FIRST

Like I said before, Wareham, Massachusetts, is not Orange County or Naples, Florida. There are plenty of other markets that are far more expensive to invest in real estate.

That being said, there will always be pockets of submarkets that are more affordable, carry less risk for the new real estate investor and are perfect for potential house flips.

So if you are new to real estate investing and house flipping, in general I highly recommend you seek out those less expensive submarkets or even neighborhoods or streets within towns that are more expensive and start there.

Doing a house flip for an ARV of $200,000 is far less risky for the new real estate investor instead of doing a house flip for $400,000 or maybe even $500,000. Even in that $400-$500,000 market, there will be submarkets, neighborhoods and even individual streets that will be more affordable.

Find them.

Seriously. Find them. Look for them. Ask your real estate broker about them. They are out there.

You may have to travel 15 or 20 miles outside of where you live, but it’s far less risky to start in these submarkets than it is to start your house flipping business in the more expensive markets.

However, if for some reason you cannot find those more affordable markets, here are some helpful steps on how you can invest in those more expensive markets by slightly breaking the 70% Rule.

When to Break The 70% Rule – USE EXTREME CAUTION

So let’s say you live in Boulder, Colorado and your market is in the $400,000 range. The 70% Rule can potentially be raised to 80% depending on many other circumstances. Although I would make the case to travel outside of Boulder to find some less expensive homes to flip, like Berthoud, CO 26 miles away with an average sales price of $266,600!

But for the sake of argument, let’s use Boulder, CO as an example.

The bottom line is this: the 70% Rule is flexible and keeps you of harm’s way –- but it depends on your market. If you just absolutely have to invest in Boulder, CO then you can potentially go to 80%.

As a general rule, the higher the price a property, the more flexibility you have on upside for the 70% Rule. In these cases over $200,000 ARV, you may consider that price range to be “higher-priced” in your market. It all depends on your local market.

But if you are going to break the 70% Rule, you have to be absolutely certain that your costs for rehab, financing, carrying costs and any other soft costs are dead on. You cannot use any “eraser math” on any of these cost projections. In addition to that, you must be prepared for the potential for downside risk.

For example, if your ARV suddenly fluctuates downward to $350,000 instead of a projected $400,000, you just gave up $50,000 in potential profits. Yikes!

Let’s say your cost projections for this flip was $60,000 for the renovation, but all of a sudden it’s now $80,000 — because of some issue with the foundation or maybe some major work is now needed on the HVAC system…are you prepared for these cost overruns?

If you’re flipping using the 70% Rule, you’ll have enough cushion to absorb these cost overruns or sudden drops in ARV.

If you use the 80% rule, you will be far less likely to turn a profit. So you need to be prepared for this potential for downside risk.

This is why it’s extremely important that when you’re first learning how to flip houses, stick as close as you can to the 70% Rule. This one simple rule has kept me out of more bad deals that I can even care to remember!

My Experience Flipping Houses with the 70% Rule

By using the 70% rule, it allows me for about a 30% margin on my flips. In some cases its higher than that. I’m very comfortable with a 30% margin because it allows for cost overruns, and gives me some flexibility with an additional value added costs.

If you aim for 30%, your take-home profit will be roughly 10 to 20% on average, once you figure in finance costs and other soft costs.

If you feel the fees disrupt the 70% Rule to the downside then just run a detailed cost analysis of all your expenses and see where you come out.

Not every flip you do is going to make you $65,000 in profit. The media and the house flipping reality TV shows make you believe that this is the case. And it’s been widely reported in some major news publications that house flippers make a ton of money on each and every flip. Its just not going to happen on every flip for you.

When you flip properties that are more expensive, there is the potential to make more profit for sure. But with that potential profit, there is increased risk. So if you break the 70% rule and go to the 80% rule instead, are you prepared?

70% or Bust?

As you may already know, every house flipping market is different, with different taxes, different lending environments and different price points. In some cases, I have gotten questions for markets as far away as Malaysia, New Zealand and Australia on this question.

As you can probably guess, the markets are slightly different from those our market house flipping in Wareham, Massachusetts!

So stick to the 70% Rule as much as you can. Adjust the 70% Rule based upon your market conditions, but don’t get too aggressive. The most important thing to remember is that the 70% Rule is there to guide you and keep you out of trouble, while ensuring a nice tidy profit in the process.

If you made it this far, leave a comment below! Have you broken the 70% Rule? How did it turn out for you? Did you make money, lose money break even? Leave a comment below and let me know!

Photo: FreeDigitalPhotos.net

About Author

Mike LaCava

Michael LaCava is a full time real estate investor, house flipping coach and the President of Hold Em Realty located in Wareham, MA. He runs the website House Flipping School to teach new real estate investors how to flip houses and is the author of "How to Flip a House in 5 Simple Steps".

23 Comments

  1. Good article Mike.
    I like to start at 65% myself to build in more of a cushion.
    I also try to be pessimistic on both ARV and repairs to be safe.
    So far my experience is sometimes things come up and it saves me and I still make an acceptable profit, and when things go well the profits are superb.

    I’m sure I’ve lost out on deals by being very conservative but I like not losing money. 🙂

    • Thats great Shaun & everyone has to do what they feel is the right decision at the time.
      finding it more competitive on mls deals these days and we can adjust higher than 70% but because I have the experience and we are doing more deals it make sense for my company.
      Always a pleasure to hear your comments and I value your opinion. Hope to see you around.

      • I agree that things are getting much tighter the last 6 months or so.
        The 1st 3 deals I sold/will sell in 2013 will be lower profits than any in 2012.
        Part of it being that a few more things came up and the cushion saved me and some of it is I DID lower my minimum profit target a little realizing that I may be able to pick up a few deals that would have slipped by before, but still being safe enough to leverage my experience to feel the numbers are pretty accurate.

        • Thats good Shawn. I am here so if you ever need to bounce any ideas or have me review anything for you just ask. Your one of the good guys. Just buy me a cold beer. Lol.

  2. A lot of great information but Fix and Flip people are leaving money on the table at closing, possibly as much as 35%.

    How? You should consider Renting or Lease Optioning the Home for a minimum time period of one year and a day and that includes the time you spent repairing the property.

    Using a 1031 Exchange will allow you to move the “Tax Free” profits into your next project and from some of the boastings I’ve read from Fix and Flip Gurus that could amount to a ton of money.

    “But I need to recoup my money as fast as I can” replies the Fix and Flip Guru.

    Okay, then partner with an IRA and let the IRA finance the deal that includes allowing you to hold the property for a minimum of a year and a day and then 1031 Exchanging. The mortgage payments due to the IRA Investor can be offset by the Lease/Rent payments.

  3. Hey mike,
    In Australia the lowest house prices don’t go much below 200k, where as in the states you can buy a house for around 40k. Would it be best to start flipping in Australia where property is more costly but I know the market, or move to the states and pursue flipping there?
    Thanks

  4. Hi Mike,
    I am a remodeler in Leominster MA and I’ve always wanted to try my hand at flipping, but I’m wondering what it takes to do it, money-wise, etc. I feel like I have an advantage since i’m in the business already, but I am correct in assuming that? Can I realistically attempt to flip a house and keep my remodeling business going, at least to start? or will I be working 100 hours a week for 3 months?
    Thanks
    Pat K

    • Hey Pat,

      When you say you are a remodeler are you the guy that does the work or do you manage the process and have a network of contractors and tradesmen to do the work for you?

      If you are the one doing the work you don’t want to spread yourself to thin by taking on a rehab that you will do all the hands on stuff while also working on other client jobs.
      If you mostly manage the process then you can probably leverage your skills and assets like a client’s project without it effecting you as long as you don’t have more projects going then you could already handle.

      Being that you are in the business of home remodeling you should have a little more credibility when talking with lenders about doing a deal. Note they will still only care about the deal overall so you need to get your ARV numbers right, but they will probably will take your rehab numbers more seriously than Joe “I’ve seen every episode of Flipping Boston”.

    • Hi Pat – Shaun has some great points and questions you should answer for us to help you narrow down your questions. It is all up to you on how many hours you work. Personally for me I eat, breath and sleep my business to be successful but I WILL NOT do it at the expense of not being the best dad and husband I can be. It is all abut balance as you climb the ladder of success. Being a contractor should be a huge asset for you to make money in this business whether you are doing the work yourself or managing the process. This will depend on your plans and goals. It can also be a double edge sword if you chose to use your talents in the wrong way like overbuilding or renovating a house beyond its ARV.
      Let us know and we will do our best to answer your questions.

      • I’m not sure if my reply ever got posted, but if not, thank you gentlemen for your answers. My biggest question I guess would be how much capital would someone need to have to get started on their first house. Lets say I was buying a house for 145,000, planned on 30,000 in repairs and sold for 250. Do the banks loan to flippers anymore? What are the soft costs that I’m missing: real estate commission, taxes (i’m assuming regular income tax rates), carrying costs (I’m assuming they start 30 days from signing of mortgage but I’m not sure, Ive only bought one house my entire life), permit fees, possibly drawings?
        I presently do all the work myself, but that would hopefully not be the case in a flip (and hopefully not be the case in my business for much longer).
        thanks guys!!

        • Hey Pat,

          The 70% rule is meant to account for most of your non repair costs. It is a rule of thumb so you should look at your actual expected costs to get a more refined look.
          But based on your example it fits that basic criteria and your other costs would be taken into account.
          Costs you want to think about are:
          – Transaction costs for both the buy and the sell (Points and lender fees are the big ones on the buy and commissions are the big ones on the sell, but there are others)
          – Financing costs, basically your payments.
          – Real Estate Taxes
          – Insurance (Pricey for rehabs compared to what you might be used to)
          – Utilities: Water/Sewer, Electric, Gas and/or Oil (Heat in the winter can be a big expense even if you are keeping it in the low 50s just to keep pipes from freezing)
          – Landscaping in the spring through fall and snow removal in the winter

          Personally don’t usually account for income taxes as they won’t change deal to deal and frankly they can be all over the place depending on the number of deals I do in a year and what other stuff I do.

          For the stuff about permits and drawings I would have that all rolled into the rehab budget. I usually put any budget for cleaning and staging in there as well, others might not but that is what I do.

          For your major question about capital needed that is a big fat “It depends”. 🙂
          You could borrow cheap money from friends and family and maybe use savings and credit you already have to fund the whole thing.
          You could find a Hard Money Lender to loan you the money, they will have varying requirements but expect to bring at least 30% of the purchase and be able to forward fund the rehab. Also expect to pay 14-18% and 3-5 points. You could do a bit better than this but for your first deal you are likely to get the higher end of any lenders rates.
          It isn’t impossible to get a regular mortgage but it might be a lot harder to close a deal with one. Also with $30K of work unless it is a TON of cosmetic stuff there is a good chance it won’t qualify for a mortgage. Also in that case expect to bring 20-30% of the purchase and fund the rehab out of pocket or some other way since there really aren’t any residential mortgages with rehab components for investors that I know of.

  5. Justin Williams on

    I would like to start flipping houses but know nothing about the business, so please excuse my ignorance. II was left a good amount of money by my grandmother and I have a very close friend (that I can trust) who just got his G.C. license and is looking for work himself. Is there any way I can find out if houses in my area (Northeast Florida) have been flipped and how much they sold for and how much cosmetic work was put into them? Or will I just need to monitor all future foreclosures in my area and see how much they will be sold for? I know this would be a tedious process but I love doing research. I know some R.E. agents too if this would help. Thanks and God Bless 🙂

    • Hello Justin – Hard to answer so many questions in this post. They are all good questions and the answers can be different depending on your are. It will be hard to know how much money was spent on the rehab. By looking at the before pictures if they were available and then the after pictures along with the original sold price and the new listing or new sold price you can some what speculate. It’s nice to know what your competition is doing but don’t get too hung up on that.
      I wouldn’t suggest forming a partnership with your friend even though you trust him and all intentions are good because if it doesn’t work out it can get messy. I would try partnering on a few deals first to see how it goes and how you guys work together before forming anything long term.

      Why don’t you colleague request me and we can chat more.

  6. Confirmation! I am closing on my first foreclosed flipper house and I figured I needed to find a house that was at least 30% under market value (the other side of your 70%): 10% for administrative and holding costs (I paid cash, so that is for insurance, utilities, LLC costs, HOA fees, etc), 10% for rehab, and — hopefully, 10% net profit before taxes. And, that is just about how it worked out. I am netting, before taxes, about $45K on a house for which I paid $401K. The house was pretty bad so, in theory, I could have done better if the house was in good shape — but always better to err on the downside when flipping.

    • Hello Sean. Good for you on the profit. Just keep in mind I deduct the cost of repairs as well after the 70%. If you buy at 70% as you did and your repairs were 20% of ARV instead of the 10% as it appears in this case you would make no money. My guess you did your math so you knew this but just want to make sure you knew how we do it. So if I was projecting and ARV of $300k with $70k in repairs I would be looking at a MAO of $140k. Good job.

    • No the soft cost are part of the 30% so you profit would be 30% minus your soft cost so if you had and ARV of $200,000 and your soft costs were 12% then 18% would be your projected profit providing you bought at 70% ARV which would be $36,000.

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