Why Blindly Following the 70% ARV Formula is For Fools

One thing that I see continually — not just in Forum discussions, but from my colleagues and fellow investors at meet ups — is the need to stick to some arbitrary number for a given property to be branded as a deal.

I don’t know if it’s out of ignorance, a strong desire to stick within their comfort zone or maybe it’s a combination of both. Whatever the case, this is something that needs to be addressed to clear the confusion. Let me say this: If you blindly follow the 70% ARV formula, it is foolish and you will let deals fall through your fingertips. In fact, sticking to any arbitrary percentage is foolish. If you keep trying to fit a square peg into a triangle slot, it will never fit. Let me explain before you guys dig out the pitchforks and torches.

Exit Strategy

Why is trying to strictly adhere to a guideline like this foolish? Part of it boils down to your exit strategy. We will be using 70% again since it’s what’s quoted on the Forums most commonly. Back before the market became tighter, I also saw other investors pass on anything they didn’t feel met the 70% guideline.

Let’s repeat that word again: These numbers are nothing more than a guideline. They are not hard and fast rules. They are meant to help steer you in the right direction; they are not some sort of binary litmus test that is either pass or fail. Let’s look at a few common exit strategies and how the 70% rule holds up:

Flip

This is where the 70% guideline is most commonly “enforced.” For flips, 70% is a good guideline, but even here you can flip in some neighborhoods on thin margins and still turn a huge profit. This is why it’s important to be an expert in your target neighborhoods, as I touch on a little bit later.

Rental

Sometimes people don’t best understand the type of exit strategy a given property qualifies for. Many times when other investors forward their deals to my inbox, I just shake my head. From experience I can see that a lot of these homes have an estimated repair cost that is more in line with a complete overhaul retail flip.

The cost discrepancy can easily be $8 to 12k and make the difference of whether the house is worth the time and money or not. As a result, other investors sometimes pass on the deals – even though they have huge potential, but not as a flip but a rental.

Owner Finance

I have seen investors buy in rough areas and make a huge profit time and time again. Read about some of the rougher houses that I have visited to get an idea. These are the sort of houses I have no interest in personally, but if you have the right network, you can easily wholesale it to another investor who regularly buys this type of housing.

For instance, one of my last wholesale deals was in a neighborhood in Dallas that was still in a transitional state. The neighborhood was bisected by a road, and everything north of the road was fine, but going south, things started to get rough. This particular house was located in the rough side of the neighborhood. But guess what? It didn’t matter.

If we were to look at the “napkin math” of this, it would be over 85% ARV. But since the investor knows the type of buyer pool for this type of house like the back of his hand, he knows that the buyers themselves are going to put in the majority of the repairs since they are unable to qualify for a traditional loan. He just does the bare minimum in the meantime. And now he has a note for 30 years that will continue to generate him income.

Your Pool of Buyers

It also depends on not just the property, its best exit strategy and the neighborhood — but also your pool of buyers. I know hedge funds in the area that will buy at 95-98% ARV, no questions asked, every time, as long as the repairs are not too substantial and the houses aren’t older than 1980. How many of these leads do you get every month and throw away into the trash can? Start converting these; find the major players in your market. I can take one of these “garbage leads,” convert it and use the profit to fund a few months of marketing.

Knowing Your Neighborhoods

Beyond picking the right exit strategy, it’s about being an expert in the neighborhoods you market to. I know several subdivisions in my backyard where flippers can make a huge return on razor thin margins. On paper these sort of deals would never pass any of these ARV guidelines. But if you were an expert in the area, you would know otherwise.

Marketing Dollars

Let’s face it, deals are coming harder to come by these days, and we need to stretch our marketing dollars as far as possible. You can spend the same amount, but bring in more deals simply by evaluating each property to see what the best possible exit strategy is – instead of trying to force arbitrary numbers like the 70% rule.

Investors: What do YOU think? Do you stick to the 70% rule religiously — or do you take it with a grain of salt?

Be sure to weigh in with a comment!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.