What Is The 70% Rule In Real Estate?
Cathie Ericson5-Minute Read
April 06, 2021
You typically find that 70% isn’t enough when it comes to a grade or other effort. But when it comes to real estate investing, it might be the magic number. That’s because one common guideline is that you shouldn’t sink more than 70% of a property’s ARV (after repair value) in an investment you’re buying to rent or flip. Let’s dig in to why the 70% rule is a good one to follow 100% of the time – or at least as a start for determining the price you eventually pay.
Understanding The 70% Rule
The 70% rule applies to the total amount you’ll be spending on the property, from its initial purchase price to the repairs or upgrades you intend to undertake to whip it into shape. Of course, this is just a rule of thumb, and yet it is remarkably useful in its simplicity as a way to confirm that you will get the most value out of the property without overpaying or over improving. The 30% difference in the property’s value and then its increased value once you have completed necessary upgrades – known as ARV – will be allocated to you as profit, as well as cover the costs you incur anytime you buy real estate. (More on those later.)
How To Calculate The 70% Rule
Purchasing an investment property can be tricky because you want to make sure you get the most return on that investment. But estimating can be a challenge when you’re purchasing real estate that needs to be improved to make it more appealing to demand top dollar, which is where the 70% rule comes in.
First you want to make sure you’re not overpaying for the market so do research and arrive at a price that’s based on comparable properties, which are nearby properties that have similar characteristics to your target. Then determine which repairs need to be done; this is a good time to involve a contractor and/or interior designer if cosmetic improvements will really help it shine. You want to make sure that your estimate is accurate, based on the cost of materials as well as workmanship. If you are handy yourself, your sweat equity can help keep the price down, but make sure to account for the time of your labor.
Once you have arrived at a purchase price and the estimate for upgrades, you have an ARV: Purchase price + Value of repairs. The 70% rule states that you should offer 70% of that to make sure you’re not paying too much for the property.
Let’s say you have found a $200,000 diamond in the rough that could really sparkle with some targeted cosmetic upgrades. You consult a contractor who advises a few minor structural changes (removing a half wall to open up an area, for example) and an overhaul of the flooring, cabinets, counters, etc. Their estimate comes in around $50,000 for the materials and work.
Your ARV is now 250,000, so when you take 70% of that, you wind up with $175,000. According to the 70% rule, that’s how much you should offer when purchasing the property as an investment.
Who Should Use It?
The 70% rule is most applicable when using the house to raise income, such as someone who is flipping a house or is a real estate investor, rather than someone who intends to live in the house long-term. That’s because when you buy a house as a primary residence, you are likely to hold it as an asset long enough to recoup the value that comes with market growth over the long term. However, if you’re planning to sell it quickly as a flipper or have it exclusively for real estate investing purposes, it’s more important to be clear on how much you’re sinking into the house in order to turn a larger profit on the investment as an asset.
When To Use It
While the 70% rule is a useful guideline when estimating your offer on a home, you may need to tweak it a bit when you consider the dynamics of your particular market. If real estate, especially fixer-uppers, are languishing in your market, you could bump down and work toward 65%. Or if real estate is red hot, you might need to adjust up a bit to hit 80%. Remember the higher you go, the less profit you will eventually realize, which is why you need to assess whether the purchase still works as you inch higher. But it’s important to remember that the 70% is a useful starting point, then you can go up or down as appropriate for the market, the size of your down payment, and other factors that go into a wise real estate investment.
Factors To Consider When Using This Rule
Heading back to that remaining 30%, you might be wondering what it will be applied to, in addition to your bank account as profit. There are many costs associated with purchasing real estate that you need to factor into the price to make sure you’re still getting a good deal on an investment property. Here are the three top ones to consider:
Any home purchase will have a long list of additional expenses over and above the property price, so you want to find out what closing costs are so you can mentally factor that in. These costs include attorney fees, home appraisals, real estate agent commissions (while the seller usually pays these, they still might be part of your negotiation), title search, title fees, and other related costs. If you’re taking out a mortgage on the property, ask your lender to estimate these fees upfront so you have a clear picture of what your eventual outlay may be.
These are costs that you pay as a consequence of holding the property, such as homeowners association fees, real estate taxes, insurance and of course, the payment if you have a mortgage. These can be defrayed if you have a renter in a real estate investment, but if you are working on rehabbing a vacant house, it will fall to you.
If you’re paying cash for the property, you are unlikely to incur lender fees. Otherwise, these are the fees associated with the mortgage, and can include the interest rate you’re charged on the mortgage, the origination fee that most lenders charge, and exit fees, otherwise known as a prepayment penalty, if you pay your loan off early (if your lender charges these). You also may end up paying more to get a “hard money loan,” as a flipper than you would for a traditional mortgage, given that private lenders are more apt to bankroll these riskier investments – and charge a bit more for their services.
Why The 70% Rule Doesn’t Always Guarantee Profit
While the 70% rule is a great place to start when estimating what you should pay for a property, remember it is just a guideline. While the local market will dictate how you might need to adjust up or down, remember that no formula can guarantee a set profit. Any number of factors can affect a real estate purchase, such as unexpected costs that pop up during the remodel or other external factors, like a house that takes longer to sell than you had anticipated.
Before you make any real estate investment, you should be clear on all the different ways costs can vary and prepare to work those surprises into your budget.
The Bottom Line
Real estate can be a lucrative way to invest your money, but only if you are able to recoup your profit. Using the 70% rule as a guideline can be a useful starting point for making an offer on a home that you intend to sell as an investment.
Wondering what else you should know before you dive into home ownership? Find more Home Buying Tips on the Rocket Homes® blog.
Table of Contents
What Is ARV And How Is It Calculated?
ARV, or "after repair value," refers to a home's value following renovations. Learn why ARV is important for sellers and investors, and how it is calculated.
How To Flip A House: A Complete Guide for Beginners
Knowing how to flip a house is a valuable skill in real estate investment. Read this easy-to-follow how-to guide and learn how to make a profit flipping homes.