If you are a house flipper or have spent any great length of time on BiggerPockets.com, you probably recognize the 70% Rule and understand how it pertains to house flippers. However, the 70% Rule can also be extremely helpful for wholesalers, especially those who may be wholesaling deals to house flippers—as you might do.
Keep in mind, this is only a rule of thumb and one of several methods you will use to estimate what you should offer on a property. The 70% Rule states that you should pay no more than 70% of a property’s ARV, minus any repairs.
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 the 70% Rule Works in the Real World
A wholesaler also needs to subtract their fees from that number. Therefore, the 70% Rule, as it applies to wholesalers, is as follows:
Maximum Allowable Offer = (ARV x .70) – Repairs – Your Fee
Let’s do some very quick math, and I’ll show you how this would work in the real world.
Wholesaler Beth was considering making an offer on 123 Main Street, the property owned by Clarence that we looked at earlier. If you’ll recall, we determined the ARV for that house to be approximately $147,333, after comparing it with 875 Elm Street, 413 Oak Street, and 77 First Street.
To determine her offer price, Beth multiplies $147,333 by .70 to get $103,133. She then subtracts the cost of the necessary repairs, which she estimates at $20,000, and her desired wholesale fee of $10,000 to arrive at a maximum offer price of $73,133.
-$10,000 (Wholesale Fee)
= $73,133 Maximum Allowable Offer
Although these numbers are fairly easy to calculate, if you want to do them quickly online, BiggerPockets has a free 70% Rule Calculator that anyone can use. Just plug in the numbers and see your Maximum AllowableOffer. To use the calculator, visit BiggerPockets.com/calc and click on the 70% Rule Calculator.
Problems With the 70% Rule
The 70% Rule assumes that 30% of the ARV will be spent on holding costs, closing costs (on both the buyer’s and seller’s side, such as commissions, taxes, attorney fees, title company fees, and more), the flipper’s profit, and any other charges that come up during the deal. This works well in many markets, but it has some severe limitations.
For example, the 70% Rule doesn’t work as well for a property whose ARV is low, such as $50,000. As mentioned earlier, the 30% deducted from the ARV includes the holding costs and closing costs, as well as the profit the investor or flipper wants to make. However, 30% of $50,000 is $15,000, so following the 70% Rule, all the fees, costs, and profit add up to only $15,000. If the fees and holding costs were to total $10,000, that would leave just $5,000 in profit for the house flipper—and I don’t know any house flipper who will take on the risk of flipping for just $5,000. So, following the 70% Rule, a flipper or wholesaler would pay far too much for the property in this case.
A similar problem with the 70% Rule exists for more expensive properties. The 70% Rule would dictate that a home with an ARV of $700,000 that needs $50,000 worth of work should produce a Maximum Allowable Offer of $440,000. However, in most markets, finding a $700,000 property for $440,000 is simply not feasible. A person who sticks exclusively to the 70% Rule will likely never find a good enough deal to ever wholesale or flip a single property.
Furthermore, some investors may spend more or less on fees and costs because of their particular life situation or location. For example, in some states, purchasing a home may require $3,000 in closing costs, while in other states, it might be $6,000. Some investors may have a real estate license, which saves them tens of thousands of dollars in commissions, whereas other investors may need to pay commissions when they sell.
[This article is an excerpt from Brandon Turner’s The Book on Investing With No (or Low) Money Down.]
What methods do you use to estimate the after repair value and maximum allowable offer for your rehabs?
Let me know with a comment!