The 70% Rule
When entering the world of real estate investing, there’s a lot of wisdom and advice that gets thrown around. One that you might have heard of but not really known what it is, might be the “70% rule”.
The 70% rule applies most often to flipping houses, but can also apply to real estate investing in general. The broad principle is that an investor shouldn’t spend more than 70% of a property’s After Repair Value (ARV) when fixing up a property, in order to leave room for profits and “miscellaneous expenses like soft costs”.
The formula is as follows:
((Property's ARV) x 0.7) - Repairs cost
= Highest amount you should pay for the property
This makes sense, because as we know, in order to get the best chance at turning a profit from a property, you generally should avoid spending more to upgrade/renovate it than you did to buy it; but there are of course cases in which putting in the money will pay off. The 70% rule provides a good starting point to let you know what should be your initial spending limit during renovations.
Now, what kinds of costs are factored into this analysis? It’s not uncommon to include costs such as financing costs, repair costs, settlement costs, other carrying costs, and a repair cost reserve (20% of known renovation costs, just in case something comes up).
An example using the 70% rule would be as follows:
Let’s say you have a property with a value of $200,000 after repairs. If the property needs $20,000 in repairs, the calculation would be
STEP ONE) 200,000 (ARV) X 70% = 140,000
Then take the total you just reached, and subtract the cost of repairs from it.
STEP TWO) 140,000 - 20,000 = 120,000
So $120,000 would be the suggested offer price using the 70% rule.
It should be emphasized here that this is not a concrete rule you need to follow when investing in real estate. It is a quick calculation you can use as a starting point, but be sure to do a more extensive analysis of the costs and benefits as well outside this calculation.