70% Rule Explained: How the 70% Rule Works in Home Buying

In real estate investing, such as in flipping houses or wholesaling, the 70% rule describes the conventional wisdom that an investor should pay no more than 70% of the property’s “after repair value,” or ARV. This means that once you have determined how much the renovations for an investment property will cost, your maximum purchase price should be no more than 70% of the value of the house with the renovation cost taken into consideration. This 70% rule is just a “rule of thumb” and not anything written in law, although there are real estate investors who stand by the 70% rule.

Let’s say you find a house that would be a perfect real estate investment, and it’s listed for $150,000. You bring in a contractor and go over the renovations you want to make, as well as any structural fixes and fixes to bring the house up to code, and they estimate the total renovation cost to be $50,000. This puts your ARV at $200,000. Applying the 70% rule, take the $200,000 and multiply that by 0.7, to end up with $140,000. That’s the number you should pay for the investment property.

Challenges of adhering to the 70% rule stem from the fact that it requires a lot of estimation. You have to estimate the necessary repair costs before you can determine your total offer price. If you’re buying a home with the intention to flip a property or make it a rental property, you first have to figure out the type of renovating you want to do—then you can determine 70% of the property’s ARV. Once you have itemized the potential renovations and estimated as accurately as possible their potential costs, you can add those costs to the purchase price of the home to determine an offer price.

It’s key to be realistic with your ARV (“after repair value”) estimations because you don’t want to do repairs that will ultimately price you out of the local market. While you don’t want to be on the lower end of that market, you don’t want to over-renovate either. This can be a reason to work with a real estate agent who knows the local markets—they might be able to guide you to an investment property with a future selling price point that will be in your favor. It’s also ideal to have a contractor or other licensed professional compile and calculate the estimated rehab costs. Estimated repair costs should be realistic but conservative, so that you don’t overpay and are able to maximize your profit margin.

If you plan to become a house flipper or otherwise buy an investment home using the 70% rule, you will want to take into consideration other buying costs beyond just the cost of potential renovations. Here are a few other costs associated with home buying:

• Carrying costs: Also known as holding costs, these are any ongoing costs the property owner must pay while they own and are fixing up the property to be resold. Carrying costs can include mortgage payments, insurance, property taxes, utilities, maintenance costs, and homeowners association fees. These costs can potentially eat into the final profits (in the event you resell the home later on), so you should estimate them at the outset of purchasing the property.
• Closing costs: These fees are a certain percentage of the home’s purchase price and usually fall between three and six percent. Closing costs are due at the time of closing and can include application fees, attorney fees, homeowners insurance, property tax, and more.
• Financing costs: If you’ve chosen a hard money lender as opposed to a traditional mortgage lender, you may have a higher interest rate. Despite that, financing through a hard money lender can be a good option for house flippers or those using homes as investment properties because the loan is for projects lasting from a few months to a few years. There could also be higher lender fees, or origination fees, associated with hard money loans, anywhere from one to five percent of the amount borrowed.
• Selling costs: If you are flipping an investment property, there are selling costs associated with the reselling of the property. One of the biggest fees is the real estate commission, which you pay to the realtor who helps you sell your house. Sellers may also have to pay for the home inspection, home staging, capital gains tax, closing fees, and more depending on the purchase agreement.

With all of these costs adding up, keep in mind your maximum allowable offer, which is the maximum amount you, as an investor, could pay for a property and still be able to realistically make a profit. It can also be helpful to have an exit strategy in case there are any unforeseen circumstances that arise.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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