I had just pulled out my driveway to head to one of our new properties in Freetown, Massachusetts.
Today was “tear down day” and I was pumped!
It had been a while since I did a tear down and I was really looking forward to seeing the excavator rip it all to shreds.
I felt like a kid on Christmas morning…totally excited to see it happen and shoot a few videos in the process.
Just then, my 2009 Chevy pickup started making funny noises.
I’m no auto mechanic, but I knew these “noises” were not just the result of sub freezing temperatures we’ve been getting here in Winter-bound Wareham, Mass these days.
Even though I knew I could probably make it to Freetown, I did the right thing and took it to my local Sullivan Tire to have them look at it.
After throwing it up on the lift they said my “ball joints” had shot. I had no idea what these are and I had even less of an idea of what it was going to cost me. I asked sheepishly the price and after the tech did a few calculations on his computer, he said it would be $798.
I couldn’t exactly “shop around” for a better deal as I was pressed for time, so I told them to do it.
That’s when I thought to myself how I wished that calculating how much to pay for truck repair was as easy as how to pay for a house flip…
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
How Much to Pay For a Flip Using The 70% Rule
How much to pay for a property…always a tough one to figure out.
Tough that is…unless you have strict rules.
Determining the comps in the area is a great start which we’ve talked about here a few times before.
From there, you heavily rely on your ARV and then from there, you need to know what the cost of repairs are going to be.
Cost of repairs is very important as well and when you do your walk-through with your general contractor, you’ll get that number.
You now have your ARV and your cost of repairs, the two most important numbers there are in house flipping. Number 1 being ARV and Number 2 being cost of repairs.
Once we know those two numbers, then we can apply our formula. It’s called The 70% Formula or otherwise known as The 70% Rule. It’s a very common formula, thousands of other investors use it besides just me, largely because it just works so well.
The 70% Rule Makes You Money
Some investors don’t quite understand how the 70% Rule works – they just know to do it, but they don’t really understand why.
But for you, you do want to understand how it works so you know how to control it and use it to your advantage to hep you make more money.
Sometimes we use a percentage different from 70%, because we have to adjust up or maybe even down based upon the property. But for the most part, when you’re getting started you want to use the 70% Rule as is – right at 70%.
So let’s see it in action, then explain after why it works so well.
A 70% Rule Example on How Much to Pay For a Flip
1. Get Your ARV
So let’s say we’re looking at buying a property with an ARV of $200,000.
To get to that number, our real estate agent has done a complete Comprehensive Market Analysis (CMA) and everything in the neighborhood is selling for $210,000, $215,000, $205,000 – all basically in that range. So based on our CMA, we’ve determined that $200,000 is a really good realistic, somewhat conservative price point.
So here’s how the 70% Rule works. All you want to do is take that $200,000 and multiply it times 0.7 – which will give you $140,000.
Now if the house is in perfect, saleable condition as is, our Maximum Allowable Offer (MAO) would be $140,000.
Great for you if that’s the case!
But the reality is as a house flipper, you don’t buy houses in perfect condition. So the chances are that you’re going to have to do some renovation.
After all, distressed properties that look like this are what you want to ideally go after.
These are properties with failed septic system, the ones that have mold, the ones that are full of trash, the dregs of the property world.
You want the properties that everyone wants to run out of the soon as they walked into it. These are the ideal types of properties for you. We have a few saying around the offices about these gems:
Mold is Gold
Smells Like Money
Well…the last one has nothing to do with these properties, but we still say it all the time anyway!
The reason why you target these kinds of properties is simple: you’re typically not competing against the retail consumer.
I digress…back to the 70% Rule…
2. Get Your Cost of Repairs
Now let’s say for the sake of argument the cost of repairs is $40,000.
To get to this number, we had our contractor come in, look at everything – including the plumbing, the roofing, the siding, what have you, and he feels pretty confident that property is going to cost $40,000 to repair.
3. Get Your MAO
The next part of the formula is when we then subtract that $40,000 from the $140,000 which gets you to $100,000.
Now we’re looking at a maximum allowed offer (or MAO) of $100,000 on this property.
So you go and offer $100,000…
Hold up there partner…not so fast!
The last thing you want to do is immediately offer your MAO. This is a common new real estate investor mistake because when you put in your maximum allowed offer amount, you don’t leave any room for negotiating.
And when that happens, you’re now stuck.
Remember that this number is your maximum number to pay, so always start lower.
WARNING! WARNING! On ARV
Yes, the 70% Rule works awesome – no doubt, but bear in mind that the formula is only as good as the starting number. Meaning that the ARV has to be extremely accurate to begin with.
Let me explain.
Let’s say you have a brand-new real estate broker and she’s very excited to get your business and she gives you an ARV of $215,000. You are psyched. You can already envision all the cool stuff you’re gonna load up on with your hefty profits…
However, she’s overly ambitious and the ARV is way too high. This impractical number now affects every other number downstream.
In this case, we take the $215,000 and multiply that by 70% – we’re now at $150,500. So instead of the $100,000 and the $140,000, we’re now at $150,500.
Although that other ARV number is only 7 or 8% more than the $200,000, these mistakes start to add up on your bottom line…for the worse.
So now we actually buy the property at $110,000. Then lets say it takes longer than you thought it was going to take to sell.
You might be into it for six, seven or let’s say eight in this scenario. This is eight months and your soft costs like interest, maintenance and upkeep and at eight months, they really add up.
In the meantime, your repairs end up costing you $50,000 instead of the $40,000 you projected.
To make matters worse, you go to sell and the real estate agent (the one who told you it would sell for $215,000, by the way) comes back and says you need to sell it for $200,000.
You’re now stuck…over budget, under ARV and into it two months longer than you expected.
The nightmare is not over….
Suddenly, the offers start coming in and they’re not even close to the $200,000. They’re coming in at $190,000, $194,000 and a few below that. So with tail between legs, you settle for an ARV of $195,000.
In this scenario, you end up making less than minimum wage on this flip…despite eight months of hard work.
The “Less Than Minimum Wage” Numbers
Lets look at the numbers:
- ARV = $195,000
- MAO = $110,000
- COR = $50,000
- Soft Costs = $26,000
- Your Net = $9,000
Now lets face facts, making $9,000 isn’t too bad. But if it took you eight months to do it, when you factor that all out over eight months…its like making $6.39 and hour for all your hard work.
The minimum wage in my state is $11, so that LESS than minimum wage!
Calculation: 22 work days/month x 8 months x 8 hours/day = 1,408 hours / $9,000 = $6.39/hour = really sucky pay for you
I certainly don’t want to be making less than minimum wage on my flips….
And that’s why these numbers, and I can’t stress it enough, are so critical. And more importantly, its vitally important that you stick to them.
The 70% Rule Unplugged
I like stuff stripped down, like the Unplugged versions of my favorite songs like this one here. Epic…
So lets look at why the 70% Rule works so well in this section.
One of the biggest questions I always get on the 70% Rule is “what is the other 30%, Mike?” Its pretty simple, here’s the breakdown:
- 10% is your soft costs – like finance charges, brokers commissions, upkeep, maintenance, snow removal, etc.
- 20% is YOUR PROFIT
So on a $200,000 ARV flip, you should be able to project a $40,000 profit if all else is equal. If you are off on any part, then what suffers is your profit, like in our example above.
And if you stick to all those rules, you will NOT make less than minimum wage…you’ll make far more and probably want to do it over and over and over and over again…making maximum wage all the way.
If you’ve made it this far, please leave a comment below! What do you think? Please leave a comment and share your questions — or ask me anything you’d like about flipping houses!