If you’ve been looking into real estate investing, then flipping houses likely crossed your mind as a way to bring in extra income. And you’re certainly not the only one.
2022 saw the highest rate of homes bought and flipped in the US, a staggering 8.4 percent of all homes purchased. House flipping is a fantastic way to invest your money and time with quick returns.
Before you purchase some fixer-uppers, you’ll want to understand the basic principles of house flipping to ensure you come out with worthwhile profits.
We’re here to help you become a successful real estate investor by first answering this key question: What is the 70 rule in house flipping?
- Flipping Houses 101
- What is the 70 Rule in House Flipping: Explained
- What You Need To Know To Use The 70 Rule
- Calculating Profits With The Rule
- When to Avoid the Rule
- Tips On The 70 Rule To Save You Time and Money
- Frequently Asked Questions
- Wrapping Up
Flipping Houses 101
The majority of property buyers want a safe and reliable home. Distressed property invokes fear of unknown repair costs, time investment, and an overall headache for buyers that just want a home to live in.
These distressed properties, therefore, sell at a low cost to get them off the market. So, many real estate investors seek out run-down properties with the potential to sell for higher if they put in some work.
They purchase property with the sole intention to fix it (improve it) and sell it for a profit rather than live in it. They buy at a low price and sell at a higher one.
House flipping requires time, skills, and money. Ensure you feel comfortable doing all of the basic aspects of the job:
- Surveying the work that will need to be done
- Purchasing the right property for the right price
- Planning the expenses and time for the project
- Knowing it will likely be more than your plan and being prepared for that
- Fixing all aspects necessary
- Putting the home up for sale for the right price
What is the 70 Rule in House Flipping: Explained
If you want to minimize expenses and maximize profits, you should never pay more than 70% of a property’s after-repair value (ARV).
Consider the ARV as the final worth of a home after all the renovations are complete. When flipping houses, real estate investors know they first have to spend money to make money. The rule helps house flippers avoid overspending on repairs.
But it also has its limitations.
Advantages of the 70 Rule in House Flipping
The 70 percent rule is a great tool for initial property planning. It provides structure and broad estimates to give a general idea of the worth of a property.
It’s best used for:
- Estimating your maximum buying price.
- Comparing properties that you’re considering.
- Negotiating property prices with the current owner.
Risks of the 70 Rule in House Flipping
Keep in mind that the rule only provides an estimate. By the end of the house-flipping process, you will likely see a different number than what this simple equation gives you.
Use the house flipping equation for purchasing and planning, but do not depend on it. Many other equations and considerations in house flipping should be paired with it to strengthen your estimations.
What You Need To Know To Use The 70 Rule
You need two important values to calculate your 70 percent rule. These must be as accurate as possible, although it will be impossible to know the perfect number because figures will always change during the process.
The two numbers are the after repair value and the repair costs. These will help you calculate your maximum purchase price for a property.
The 70 Percent Rule For Flipping Houses Formula
In mathematical terms, the formula is:
0.70 × (ARV) – Repair Budget = Maximum Purchase Price
For those that get lost in math, think of it this way. You calculate a home’s ARV to be $300,000 but needs $50,000 in repairs.
The 70 percent rule states you should pay no more than $160,000 for the home.
$300,000 × 0.70 = $210,000.
Subtract the estimated repairs of $50,000, and you get $160,000.
Understanding the After-Repair Value
This is an essential value to calculate before purchasing a property. If you’re incorrect, you may risk losing a lot of your money in the end.
While it’s impossible to predict the market, you can speak to advisors in real estate and come up with the most reasonable prediction.
Understanding the Repair Costs
Calculating your estimated repairs will always be difficult because things change as you begin the repair process.
Ensure you create a detailed analysis before purchasing a property. You must be comfortable with additional expenses appearing throughout the process, as this is common.
It’s essential to understand what needs to be repaired, what you can tackle, and what will need to be outsourced. Having others do the work for you is expensive, and the cost analysis must be realistic.
Consider working with a home inspector or contractor in the field to get the most accurate figure.
Calculating Profits With The Rule
Understand that the 70 rule gives you an estimate, not a final figure. House flipping has many unexpected expenses throughout the process that must be considered in addition to this formula.
Beginner house flippers also believe the remaining 30% is their profit but this ignores many additional hidden costs that need to be considered.
To get a better profit estimation, use the 70 percent rule and then subtract all the additional costs that will be associated with the process and project.
Some hidden costs you can encounter include:
- Commission for the real estate agent
- Expenses related to the initial purchase
- Closing costs
- Examination of property title
- Lender fees
- Materials for construction
- Substituting household appliances
- Workforce and contractor services by experts
- Gardening and outdoor area fees
- Costs for preparing the property for sale
- Taxes associated with property transfer (amount varies based on location)
- Marketing fees
When to Avoid the Rule
Of course, a strict rule doesn’t fit every scenario. You should consider the unique needs of your project and hidden expenses that may alter the numbers.
The housing market is volatile. Understand that property is a risky investment, as you’re betting that the housing market will be in your favor by the time you’re ready to sell.
If the ARV is low, such as under $100,000, you must consider a higher risk. With possible profits on the low end, it leaves less room for error and additional repairs.
For more expensive homes, the opposite is true. You may be able to make the flip happen with an 80 or 90 percent rule rather than 70. A million-dollar home will have more room for additional renovation costs without as much risk.
Tips On The 70 Rule To Save You Time and Money
Here are some tips that can help you leverage the 70 rule:
1. Network to Learn
In the real estate market, plenty of estimated numbers are thrown around. This is risky if you’re making calculations without knowing which direction the trends will go. One of the best ways to reduce this risk is to network with the experts.
Some people have been in this industry for decades and have seen the market shift. It does follow patterns, and the house-flipping market will respond in ways that have been seen before.
Find those who know these trends and are willing to teach out and warn you about mistakes they’ve made in pre-purchase estimates. Conferences, local meet-ups, and social media are all great ways to do this.
2. Use Conservative Numbers
You’ll never regret using conservative numbers in your calculations. The best-case scenario is that you see a decent profit and are prepared for any surprise expenses. The worst-case scenario is that you’re much closer to your predicted profits than if you didn’t use conservative numbers.
3. Know Your Skills (& Up Them!)
Labor is one of the highest expenses for flipping houses. If you’re handy and capable with tools, you’ll save money by doing the work yourself. It’s called sweat equity and can greatly reduce your repair costs and increase your profits.
4. Risk Acceptance
You must be risk tolerant in this industry. The formula only provides an estimate and can’t be trusted as a perfect figure.
The income is not guaranteed, and there is always a chance you’ll lose money on a project. Ensure you can handle stress and be comfortable with unknowns that may lie ahead.
If this type of work would take too much of a toll on your mental or physical health, consider alternatives.
5. Capital Gains Tax Is A Huge Hidden Cost
The capital gains tax (CGT) is relevant to house flipping, and you must understand it before jumping into real estate investing. The CGT is often associated with stock investments, but it also applies to real estate if you’re buying and selling in the short term.
You’ll pay the IRS a portion of your profits. This number varies based on your income bracket but can be anywhere from 10 percent to 37 percent.
The percentage is calculated from your total profit, so all other expenses will not be considered. If you flip a house and, after all expenses, make $30,000 as your total income for the year, the IRS will take at least $3,000.
You’ll need to talk to a tax specialist or refer to your income bracket to consider the CGT for your calculations. It should be the final calculation reduced from your estimated profit.
Frequently Asked Questions
How Does The Length of the Project Impact The 70 Percent Rule?
Each day that your money is tied to the house costs you money. You’ll be paying holding costs, such as the mortgage, utilities, property taxes, and insurance on the property.
The unavoidable costs must be considered and calculated into the formula, so you need a reasonable estimate for yourself for flipping.
How Much Do The Hidden Costs Typically Take From The 30 Percent?
According to Attom, the average return on investment for house flipping in 2022 was 26.9%. This was equivalent to an average of $67,900 gross profit, but of course, yours will depend on the size of the project.
Using the 70 percent rule is valuable when predicting numbers for a house flipping project, but it takes a more detailed analysis to truly recognize the potential profits.
It’s a great tool when looking at properties, but before you purchase one, follow the steps mentioned in this article. Hidden costs and the volatility of the market are risky variables that you must calculate as well.
Have fun flipping your house and make sure to stay smart with your investments. If this article helped you to do so, please comment or share it with friends.