How Does the 70% Rule in Real Estate Work?

The 70% rule in real estate is a guideline that many investors use to determine the maximum price they should pay for a property in order to make a profit. The rule states that an investor should not pay more than 70% of the after-repair value (ARV) of a property, minus the cost of repairs.

It is important to note that the 70% rule is just a guideline and not a strict rule that must be followed. Some investors may adjust this percentage based on their own risk tolerance, market conditions, and other factors. Additionally, some investors may use a different rule such as the 75% or 80% rule depending on their investment strategy and goals.

What Is the 70% Rule?

When investing in a home that requires significant repairs, especially for flipping, you'll need to estimate repairs accurately and account for unexpected expenses. In addition, you'll need to understand the market and comps to estimate the final resale value. To accurately estimate and turn a profit, house flippers and real estate investors often use the 70% rule.

The 70% rule states that you shouldn't pay more than 70% of a property's after-repair value minus repairs. What that means in practice is that if a home's after-repair value is $200,000 and it needs $40,000 in repairs, the investor shouldn't pay more than $100,000.

The 70% rule comes from years of real estate investors' experience in house flipping. It's not a precise formula. Instead, it's a quick rule of thumb to help you roughly determine the maximum purchase price. At this point, a tried and tested guide should give you a reasonable estimate as long as you're skilled at estimating both repair costs and final sale value.

Understanding the Formula

The 70% rule calculation is simple, which is one of the reasons it's so convenient. Here is the formula with the after-repair value abbreviated as ARV:

ARV * 0.7 - Repair Costs = Maximum Offer

• After repair value is how much you can reasonably expect to make selling the house or the home's market value.
• Repair cost is the cost of all expected renovations, including both major and cosmetic repairs or upgrades.
• Your maximum offer is the maximum amount you should submit to the seller to purchase the property.

The formula helps determine the maximum offer a real estate investor should make. For example, in the example above, your total investment by the 70% rule, plus repairs, would be $140,000. You could reasonably expect to make up to $60,000. But if costs run over, the market changes or you're not able to sell the home as quickly as expected, you should still turn a profit.

Benefits of Using the 70% Rule

The 70% rule benefits real estate investors for many reasons, but the primary benefit is the convenience it offers to make profitability calculations. The 70% rule of real estate can help you avoid overpaying for properties, factor in the cost of repairs and ensure sufficient knowledge to identify profitable deals for smart investment decisions.

It factors in potential repair costs and ensures a profit margin even with common cost overruns or a longer timeline.

Common Mistakes to Avoid

Common mistakes that real estate investors make when using the 70% rule are:

• Underestimating repair costs
• Overestimating after-repair value
• Underestimating repair time (linked to repair costs)

The solution to avoid these pitfalls is to research. Understand your target markets and work with qualified real estate professionals to compare comps and get an accurate estimate of after-repair value.

Likewise, if you don't have experience estimating repair costs, work with qualified contractors, inspectors and trusted professionals who can help you more accurately estimate repair costs.

With time, research and experience, you can estimate these values more accurately, but even experienced real estate investors make mistakes. For that reason, gathering a trusted team to help with estimates and market research can increase the chances of success and help avoid calculation errors that could eliminate profits.

How to Use the 70% Rule

The 70% rule is a good starting point if you're investing in real estate. Here's an overview of how to use the 70% rule in various scenarios.

Applying the 70% Rule in Real Estate Deals

Suppose you see two properties in a target market. They are both three-bedroom, three-bathroom homes whose after-repair value will be around $160,000. You want to compare them to decide on the best investment opportunity.

House 1 has issues with the roof. You estimate repairs will be at least $60,000 and increase the estimate to $65,000 to be safe. On this house, applying the 70% rule, you'd offer a maximum of $47,000 ($160.000* 0.7 - $65,000 = $47,000).

House 2 is in good condition, but you want to paint, and update the kitchen and one bathroom. You estimate repairs will be $35,000. On this house, applying the 70% rule, you'd offer a maximum of $77,000 ($160.000* 0.7 - $35,000 = $77,000).

Whether you choose house one or house two depends on several factors, such as:

• Which property has more potential for other unaccounted-for repairs
• Your timeline for flipping and whether you have time for the major repairs
• Your confidence in repair estimates and resale estimates
• Which seller is more willing to negotiate or needs a fast sale

The 70% rule loses its value if you cannot accurately estimate both repair costs and after-repair value, so gaining skill in accurate estimates is essential.

When to Make Exceptions

The 70% rule accounts for a large profit margin, and there may be instances where deviating from the 70% rule can be reasonable. For example, if the market is hot or appreciating quickly, you may be able to sell the home for more. Likewise, the 70% rule may not give you enough margin in a slow buyer's market.

That's why it's essential to know the markets, understand the trends and work with qualified real estate professionals who can help you gauge possibilities. Carefully evaluate and make informed decisions when deviating from the rule and when applying the rule to make the best decision for the market, the property, your budget and your timeline.

Tips for Successful Real Estate Investing

Additional tips and advice for real estate investors to achieve success include:

• Network: Building a network of trusted professionals in the real estate industry, from investors to contractors to agents, can ensure you can get work done on time, find new opportunities or better understand markets.
• Research: Research target markets, repair costs, contractor costs and market trends to capitalize on opportunities.
• Due Diligence: Related to research, performing thorough due diligence on every property and extensive market analysis is essential for success.
• Keep Learning: Successful investors understand that markets keep changing and new opportunities can arise in unexpected areas. Connect with others through online forums, educational courses, discussions and conferences.

Final Tips on the 70% Rule in Real Estate

Real estate investing requires an understanding of both broad principles and specific markets. The 70% rule real estate is a starting point. Research, understanding and a strong network of real estate professionals can all increase your success and increase the chances of accurate estimates.

Work with a trusted real estate agent, inspector and contractors to ensure speed and accuracy in your estimates and reduce the risk of errors or losses. Considering other types of real estate investment? Find how to get into real estate investing or how to buy a rental property here.

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