The 70% Rule

What is The 70% Rule?

The 70% Rule is a fundamental guideline used by real estate investors, particularly those involved in fix-and-flip projects, to determine the maximum price they should pay for an investment property. It dictates that an investor should pay no more than 70% of the property's After Repair Value (ARV) minus the estimated repair costs. This rule serves as a quick and effective way to ensure a sufficient profit margin and mitigate risk in a renovation-heavy investment.

The primary purpose of the 70% Rule is to provide a conservative estimate for the Maximum Allowable Offer (MAO) on a distressed property. By adhering to this guideline, investors aim to build in enough equity and profit potential to cover unexpected costs, market fluctuations, and the inherent risks associated with property rehabilitation and resale. It's a cornerstone for many successful flippers, helping them avoid overpaying for properties and ensuring a viable path to profitability.

How The 70% Rule Works

The 70% Rule is applied using a straightforward formula that calculates the Maximum Allowable Offer (MAO). The formula is as follows:

Maximum Allowable Offer (MAO) = (After Repair Value (ARV) * 0.70) - Estimated Repair Costs

This formula ensures that after purchasing the property, completing the renovations, and selling it, the investor has a reasonable chance of achieving their desired profit, typically aiming for a 30% gross profit margin on the ARV to cover all other expenses like holding costs, selling costs, and actual profit.

Key Components Explained

• After Repair Value (ARV): This is the estimated value of the property after all necessary repairs and renovations have been completed. Accurately determining the ARV is crucial, as it forms the basis of the entire calculation. Investors typically use a Comparative Market Analysis (CMA) to assess the value of similar, recently sold, fully renovated properties in the immediate area.
• Estimated Repair Costs: This includes all expenses associated with bringing the property up to its full potential, making it competitive with other renovated homes in the market. These costs encompass materials, labor, permits, architectural fees, and any other direct expenses related to the renovation. It's vital to create a detailed scope of work and get multiple bids to ensure an accurate estimate.
• Maximum Allowable Offer (MAO): This is the highest price an investor should be willing to pay for the property to ensure they can still achieve their target profit margin after accounting for renovation costs and the 70% rule's built-in buffer. Offering above the MAO significantly increases the risk of a project becoming unprofitable.

Step-by-Step Application of The 70% Rule

Applying the 70% Rule systematically helps investors make informed decisions and avoid common pitfalls. Follow these steps to effectively use the rule in your fix-and-flip analysis:

1. Determine the After Repair Value (ARV): Begin by thoroughly researching comparable sales (comps) in the property's immediate vicinity. Look for homes that have recently sold (within the last 3-6 months), are similar in size, bedroom/bathroom count, and have been fully renovated to a modern standard. Adjust for any differences in features or lot size. This step requires a keen eye for market trends and property valuation.
2. Estimate All Repair Costs: Conduct a detailed inspection of the property to identify all necessary repairs and desired upgrades. Break down costs into categories like demolition, framing, plumbing, electrical, HVAC, roofing, windows, kitchen, bathrooms, flooring, paint, landscaping, and exterior work. Obtain quotes from contractors or use reliable cost estimation tools. Always add a contingency fund (typically 10-20%) for unforeseen issues.
3. Calculate the Maximum Allowable Offer (MAO): Once you have the ARV and estimated repair costs, plug them into the 70% Rule formula: MAO = (ARV * 0.70) - Estimated Repair Costs. This calculation will give you the highest price you should offer for the property.
4. Factor in Closing and Holding Costs: While the 70% Rule primarily focuses on ARV and rehab, it's crucial to remember additional expenses. These include purchase closing costs (e.g., title insurance, legal fees), loan origination fees, holding costs (e.g., property taxes, insurance, utilities, loan interest for the renovation period), and selling costs (e.g., real estate agent commissions, seller concessions, closing costs for the buyer). These are typically covered by the 30% buffer, but a detailed pro forma is always recommended.
5. Negotiate and Acquire: Use your calculated MAO as your negotiation ceiling. Be prepared to walk away if the seller's asking price is too high. Remember, the goal is to acquire the property at a price that allows for a healthy profit margin.

Real-World Examples and Scenarios

Let's illustrate the 70% Rule with several practical examples, demonstrating how it guides investment decisions under different circumstances.

Example 1: Standard Fix-and-Flip Opportunity

Scenario: You've identified a distressed single-family home in a desirable neighborhood. After thorough research, you estimate its After Repair Value (ARV) to be $400,000. Your detailed contractor bids indicate that the total estimated repair costs will be $50,000.

• ARV: $400,000
• Estimated Repair Costs: $50,000

Calculation:

MAO = (ARV * 0.70) - Estimated Repair Costs

MAO = ($400,000 * 0.70) - $50,000

MAO = $280,000 - $50,000

MAO = $230,000

Conclusion: Based on the 70% Rule, your Maximum Allowable Offer for this property should be $230,000. This leaves a $120,000 buffer ($400,000 ARV - $230,000 MAO - $50,000 Rehab) to cover holding costs, selling costs, and your desired profit.

Example 2: Property with Extensive Rehab Needs

Scenario: You're looking at a property that requires a full gut renovation due to significant structural issues and outdated systems. Its estimated ARV is $550,000, but the repair costs are substantial, estimated at $120,000.

• ARV: $550,000
• Estimated Repair Costs: $120,000

Calculation:

MAO = ($550,000 * 0.70) - $120,000

MAO = $385,000 - $120,000

MAO = $265,000

Conclusion: Despite a higher ARV, the extensive repair costs significantly reduce the MAO to $265,000. This highlights how critical accurate repair cost estimation is, as it directly impacts your purchasing power and potential profitability.

Example 3: Applying the Rule in a Soft Market

Scenario: In a softening real estate market, you find a property with an ARV of $300,000 and estimated repair costs of $40,000. However, due to increased market risk and longer selling times, you decide to apply a more conservative 65% rule instead of 70% to build in a larger safety net.

• ARV: $300,000
• Estimated Repair Costs: $40,000
• Adjusted Rule: 65%

Calculation:

MAO = (ARV * 0.65) - Estimated Repair Costs

MAO = ($300,000 * 0.65) - $40,000

MAO = $195,000 - $40,000

MAO = $155,000

Conclusion: By adjusting the rule to 65%, your MAO drops to $155,000. This provides an additional $15,000 buffer compared to the 70% rule, which could be crucial in a less predictable market, helping to absorb potential losses from longer holding periods or lower-than-expected sale prices.

Example 4: Accounting for Holding and Selling Costs

Scenario: A property has an ARV of $600,000 and estimated rehab costs of $75,000. Beyond the 70% rule, you want to explicitly account for estimated holding costs (loan interest, taxes, insurance, utilities) of $15,000 for a 6-month renovation and selling costs (commissions, closing costs) of $36,000 (6% of ARV).

• ARV: $600,000
• Estimated Repair Costs: $75,000
• Estimated Holding Costs: $15,000
• Estimated Selling Costs: $36,000

Calculation (Modified 70% Rule):

MAO = (ARV * 0.70) - Estimated Repair Costs - Holding Costs - Selling Costs

MAO = ($600,000 * 0.70) - $75,000 - $15,000 - $36,000

MAO = $420,000 - $75,000 - $15,000 - $36,000

MAO = $294,000

Conclusion: By explicitly subtracting holding and selling costs from the 70% calculation, the MAO is further reduced to $294,000. This more conservative approach provides a clearer picture of the true maximum offer, ensuring that all significant expenses are accounted for before the 30% profit buffer is even considered.

Limitations and Criticisms of The 70% Rule

While the 70% Rule is a valuable tool, it's not without its limitations. Investors should understand these caveats to apply the rule effectively and avoid over-reliance.

• Market Variability: The 70% rule is a general guideline. In extremely hot seller's markets with rapidly appreciating values, some investors might successfully operate with a 75% or even 80% rule. Conversely, in slow or declining markets, a more conservative 60% or 65% rule might be necessary to account for longer holding times and potential price drops.
• Hidden Costs and Contingencies: The rule assumes accurate repair cost estimation. However, unexpected issues (e.g., mold, foundation problems, outdated wiring) can arise during renovation, significantly increasing costs. Always budget a contingency fund (10-20% of rehab costs) to absorb these surprises.
• Experience Level: Highly experienced investors with established contractor relationships and efficient processes might be able to work with tighter margins, sometimes exceeding the 70% guideline. Beginners, however, should strictly adhere to or even be more conservative than the 70% rule.
• Property Type and Niche: The 70% Rule is primarily designed for single-family residential fix-and-flip projects. It may not be directly applicable to commercial properties, multi-family units, or niche investments where valuation methods and profit margins differ significantly.
• Excludes Other Costs: The basic 70% rule formula does not explicitly account for holding costs (loan interest, taxes, insurance, utilities during renovation) or selling costs (real estate commissions, closing costs). While the 30% buffer is intended to cover these, a more detailed financial analysis is always recommended.

Integrating The 70% Rule with Other Investment Metrics

While powerful, the 70% Rule should be used in conjunction with other financial analysis tools to gain a comprehensive understanding of a deal's viability. It's one piece of a larger puzzle.

• Return on Investment (ROI): After determining your MAO using the 70% Rule, calculate the projected ROI for the project. This will show you the percentage return on your total capital invested (purchase price + rehab costs + holding costs). A strong ROI validates the 70% Rule's application.
• Cash-on-Cash Return: While primarily for buy-and-hold, understanding how much cash you're putting into the deal versus the potential cash profit can still be a useful metric, especially if you're using hard money or private loans.
• Capitalization Rate (Cap Rate): For properties that could potentially be held as rentals (even if the primary strategy is flip), understanding the potential cap rate can provide an alternative valuation perspective and a fallback strategy if the flip market softens.
• Gross Profit Margin: The 70% Rule inherently targets a 30% gross profit margin on the ARV. Continuously track your actual gross profit margin on completed projects to refine your application of the rule and ensure it aligns with your financial goals.
• Due Diligence: No rule replaces thorough due diligence. Always verify ARV estimates with multiple sources, get detailed contractor bids, and understand all potential costs and risks before committing to a purchase.

Best Practices for Applying The 70% Rule

To maximize the effectiveness of the 70% Rule, consider these best practices:

• Accurate ARV Estimation is Paramount: The entire calculation hinges on a realistic After Repair Value. Overestimating ARV is one of the most common mistakes that can lead to significant losses. Consult with experienced real estate agents, appraisers, and use robust CMA tools.
• Detailed Rehab Cost Analysis: Don't guess. Walk through the property with experienced contractors, get multiple bids, and create a line-item budget. Account for every detail, from demolition to final cleaning.
• Always Include a Contingency: Unexpected issues are common in renovations. A 10-20% contingency fund on top of your estimated repair costs is a non-negotiable best practice.
• Understand Local Market Nuances: The 70% rule is a guideline. Adapt it based on your specific market's speed, demand, and typical profit margins. Some markets may require a 65% rule, while others might allow for 75%.
• Don't Rely Solely on One Rule: Use the 70% Rule as a quick filter, but always follow up with a comprehensive financial analysis that includes all acquisition, holding, and selling costs, as well as projected profit and ROI.