70% Rule

What Is the 70% Rule?

The “seventy percent rule” (or, “70% rule” or “70-30 rule”) is a commonly used guideline for real estate investing.  It recommends that the all-in cost of a property should exceed no more than 70% of its after-repair value.  It helps home flippers mitigate risk and increase the chance of a successful investment.

It is most commonly used in residential real estate investing but can also be applied to commercial real estate.

So, how do you put the 70% into practice?

How To Use the 70% Rule

Calculating the seventy percent rule is easy.

Estimate your ARV.  Estimate your cost of repairs.  Multiply the ARV by 70% then subtract the repair costs.  The result is your maximum recommended offer price.

(ARV * .7) – Repairs = Maximum Offer

For example:

You have found a property with an estimated ARV of $100,000 and repair costs of $10,000.  70% of 100,000 is 70,000.  Subtracting another 10,000 for that leaves you with 60,000.  Therefore, your maximum offer should be $60,000.

This provides you with a 30% buffer for other expenses.

• Closing Costs – lender fees, title insurance, commission, etc.
• Holding Costs – property insurance, interest, utilities, yard maintenance, property taxes, etc.
• Selling Costs – listing fees, property photography, staging, etc.
• Unexpected Expenses – unforeseen repairs, construction delays, extended carrying, etc.

And don’t forget your profit!

This 70% rule is especially useful for beginners.  It provides a guideline when you don’t have much experience estimating all of these expenses in detail.  Eventually, you’ll want to develop the skills to work backwards from your desired profit.

Of course, the 70% rule is only a rudimentary tool to help make your P&L work.  You should adjust it based on your specific strategy.

Moreover, passing the 70 percent test doesn’t necessarily make a property a good investment.  Nor does failing the 70 percent test automatically make a property a bad investment.

It is a very basic calculation, which is both a benefit and a drawback.

Pros: When to Use the 70% Rule

There are two sides of the 70% rule.

First, it gives you a quick way to compare potential investments.  Second, it helps you set financing and other expense targets.

• Filtering Properties – The 70% rule can be used as a filter for distressed properties and other off-market deals.  Apply it to each prospective deal to weed out less profitable investments.  Once you have enough of them under your belt, you’ll be able to look at your deal history to find a more precise standard like 66% or 72%.  It’s also wise to supplement it with other rules or metrics.
• Expense Budgeting – Once you’ve locked in on a deal, your goal is to keep those costs below 30%.  This gives you negotiating benchmarks for your loan, home service contractors, real estate agent, and other parties.  You can often get better rates as you develop your working relationships.  And of course, getting a lower purchase price can buy you additional wiggle room.

As far as real estate analysis methods are concerned, you could certainly do worse.

Still, the seventy percent rule is neither perfect nor comprehensive.

Cons: When Not to Use the 70% Rule

There are situations where the 70% rule falls flat.

After all, it is only a starting point.

Luckily, its weaknesses are fairly distinct:

• Bad Timing – The 70% rule (and house flipping in general) is susceptible to timing issues.  Buying at the top of the real estate market cycle can be especially deadly.  The fix-and-flip model is not designed for extended holding periods—which are often the only way to get your desired selling price in the event of a real estate market crash.  This makes avoiding contracting delays even more important.
• Limited “Sweet Spot” – The 70% rule only works within a given range, and within certain markets.  Like is often the case with broad real estate investing rules, it may be impossible to find properties that pass the test in very expensive cities.  Nowadays, the number of locations on this list is expanding, as margins shrink.  (On the flip side though, you can lower your target profit percentage on more expensive properties.)

How well the seventy percent works for you is highly dependent on the situation and your specific strategy.

Regardless, understanding how the 70% rule works is part of a strong foundation.  From here, you should be able to use it to develop your own system to make sure you get great profit margins on your flips.